What I Learned From the Crisis
At yesterday’s lunch, Tyler asked us to name the most important lesson we learned from the crisis of 2008. My answer: The Fed is much worse than I thought. I used to think we could trust an economist of Bernanke’s caliber to deliver tolerably good macro performance using inflation targeting – and avoid giving barbarous politicians the excuse to push bailouts and “fiscal stimulus.” Instead he threw his own principles to the wind, joined the sky-is-falling chorus, and helped end the Great Moderation.
In all fairness, you might object, “Didn’t you always hate the Fed?” But in all honesty, my answer is No. Yes, the Austrians – especially Rothbard – taught me to loathe the Fed in my late teens, and blame it for all macroeconomic evils. By grad school, however, I came to see the flaws in the Austrian theory of the business cycle. And while grad school taught me about mainstream and public choice critiques of central banking, it also persuaded me to consider the possibility that the Fed turned over a new leaf after the 1970s.
At first, the evidence was modest: By 1995, the U.S. had enjoyed a decade of historically low inflation, low inflation volatility, stable output, and tolerable unemployment. Maybe just a fluke, right? But the good times kept rolling. By 2005, I looked back and saw two decades of increasingly impressive results.
My first-hand acquaintance with high-ranking Fed officials like my teacher Ben Bernanke lulled me further into a false sense of security. I spent a semester in the front row of his class, and while he was no libertarian, he struck me as a reasonable, thoughtful, decent, market-oriented economist. With guys like him running the Fed, I figured, nothing outrageous is going to happen.
Normatively, I still favored the privatization of money. (See here, here, and here). But the Fed’s performance seemed so close to optimal that I lost interest in the topic. In a world with monstrously harmful and unjust policies like immigration restrictions, 2% inflation didn’t seem worth worrying about.
Then came 2008. As Sumner keeps telling us, all of Bernanke’s research prescribed a simple solution: Maintain nominal GDP, and let the other chips fall where they may. This might have meant quantitative easing instead of targeting short-term interest rates, but that’s it. Instead Bernanke became a key accomplice for the disgraceful series of bailouts, fiscal stimulus, and obfuscation about the zero nominal bound. The latest round of quantitative easing makes Bernanke’s doublethink plain; if he thinks it’s going to work in 2010, why wouldn’t it have worked in 2008? And if it would have worked in 2008, why did he join Paulson and Bush’s stampede?
In the end, Bernanke’s behavior baffles me. He abandoned his own intellectual positions without explanation, humiliated himself, sparked a terrible recession, set a long list of dangerous precedents, and pushed the U.S. and the world down the road to serfdom. My best guess is that he simply didn’t have the backbone to tell people like Paulson and Bush that they didn’t know what they were talking about. Whatever the reason, though, the crisis forced me to rethink my optimism about the Fed. Bernanke and company ignored their own research, got predictably bad results, and pleaded impotence. Instead of playing the voice of reason, they acted like they’d believed in bailouts and fiscal stimulus all along. I expected better. I was wrong.
I still think that technocratic economists select better monetary policies than elected politicians would. But after 2008, that’s not saying much.