Scott Sumner  

What Bernanke was up against

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David Levey directed me to a post by Douglas Campbell describing the climate of opinion within the Fed during the Great Recession:

Even as the economy was tanking in 2008 and 2009, Bell writes that "Warsh adopted a skeptical and increasingly oppositional posture. He doubted the Fed could do much good without creating much bigger problems."

Much bigger problems? What could be a bigger problem than letting the economy burn in a financial crisis?
"In March 2009 he told his Fed colleagues that he was "quite uncomfortable with the idea of purchasing long-term Treasuries in size" because "if the Fed is perceived to be monetizing debt and serving as a buyer of last resort in the name of lowering risk-free rates, we could end up with higher rates and less credibility as a central bank.""
The Fed should hold off on more stimulus in the worst recession in 75 years because it might actually end up with higher rates and lose credibility? Why wouldn't the Fed lose credibility if it was perceived as not fighting the recession? Warsh continued to warn about the dangers of both monetary and fiscal stimulus in 2010.

Warsh was also far and away not the only crazy one at the Fed at that time. In 2011, when I worked as a Staff Economist at the President's Council of Economic Advisors, I had a conversation with Daniel Tarullo, who told me he believed that Jean-Claude Trichet's interest rate hikes in 2010 -- which are widely seen to have been premature and to have helped ignite the European Debt Crisis -- were justified. These comments suggested to me that Tarullo was somewhere to the right of Genghis Khan on monetary policy. Then, there were also worthies like Richard Fisher, Often Wrong but Seldom Boring, who "warned throughout most of 2008 that inflation was the primary danger to the economy".

Imagine you are Ben Bernanke, trying to prevent another Great Depression. In 2009, Obama picks Tarullo to fill one of the empty seats at the board. You expect an ally, and instead you get someone who supports the ultra-reactionary polices of Trichet, who tightened policy in 2011 (not 2010), driving the eurozone into a double-dip recession.

Even Fed chairs must, to some extent, go with the flow. The following is very revealing, as it tells us that the prevailing view back then was hawkish:

In 2011, I also had a conversation with Ben Bernanke. I saw as soon as I began talking to him that he figured I would criticize him for QE, or inciting hyperinflation with all this money printing. He was actually surprised when I asked him why he wasn't doing more, given that core inflation at the time was running around 1.4%.
One person can only do so much, particularly when the prevailing opinion is going in the opposite direction.

Over the past 8 years I've been arguing that the economics profession as a whole caused the Great Recession. We let down the public, forgetting everything we have been teaching our students for decades---don't let NGDP crash, and if it does do everything humanly possible to get it restored ASAP. It wasn't just Tarullo, we as a profession failed the public.

Comments and Sharing

COMMENTS (9 to date)
Alan Goldhammer writes:

I'm pretty sure that our mea culpa is a rarity among the economics profession.

marcus nunes writes:

The 2008 “Dream Team”
Either the financial system is going to implode in a major way, which will lead to a significant further easing, or it is not.
But I should follow the philosophy of Charlie Brown, who I think said, “Never do today what you can put off until tomorrow.” [Laughter]
Deleveraging is likely to occur with a vengeance as firms seek to survive this period of significant upheaval… I support alternative A to reduce the fed funds rate 25 basis points. Thank you.
I also encourage us to look beyond the immediate crisis, which I recognize is serious. But as pointed out here, we also have an inflation issue. Our core inflation is still above where it should be.
MS YELLEN. I agree with the Greenbook’s assessment that the strength we saw in the upwardly revised real GDP growth in the second quarter will not hold up. Despite the tax rebates, real personal consumption expenditures declined in both June
and July, and retail sales were down in August. My contacts report that cutbacks in spending are widespread, especially for discretionary items. For example, East Bay plastic surgeons and dentists note that patients are deferring elective procedures. [Laughter]
Meanwhile, an inflation problem is brewing. The headline CPI inflation rate, the one consumers actually face, is about 6¼ percent year-to-date…My policy preference is to maintain the federal funds rate target at the current level and to wait for some time to assess the impact of the Lehman bankruptcy filing, if any, on the national economy.
As I said, it is my view that the current stance of policy is inconsistent with price stability in the intermediate term and so rates ultimately will have to rise.
Given the lags in policy, it doesn’t seem that there is a heck of a lot we can do about current circumstances, and we have already tried to address the financial turmoil. So I would favor alternative B as a policy matter. As far as language is concerned with regard to B, I would be inclined to give more prominence to financial issues. I think you could do that maybe by reversing the first two sentences in paragraph 2. You would have to change the transitions, of
But I think we should be seen as making well-calculated moves with the funds rate, and the current uncertainty is so large that I don’t feel as though we have enough information to make such calculations today.
Given the events of the weekend, I still think it is appropriate for us to keep our policy rate unchanged. I would like more time to assess how the recent events are going to affect the real economy. I have a small preference for the assessment-of-risk language under alternative A.
In fact, it’s heartening that compensation growth is coming in a little below expected in response to the energy price shock this year. This has allowed us to accomplish the inevitable decline in real wages without setting off an inflationary acceleration in wage rates.
I think what we did with Lehman was the right thing because we did have a market beginning to play the Treasury and us, and that has some pretty negative consequences as well, which we are now coming to grips with.
I think it’s too soon to know whether what we did with Lehman is right. Given that the Treasury didn’t want to put money in, what happened was that we had no choice…I hope we get through this week. But I think it’s far from clear, and we were taking a bet, and I hope in the future we don’t have to be in situations where we’re taking bets.
Mr. FISHER. All of that reminds me—forgive me for quoting Bob Dylan—but money doesn’t talk; it swears. When you swear, you get emotional. If you blaspheme, you lose control. I think the main thing we must do in this policy decision today is not to lose control, to show a steady hand. I would recommend, Mr. Chairman, that we embrace unanimously—and I think it’s important for us to be unanimous at this moment—alternative B
Those would be my suggestions to try to strike that balance—that we are keenly focused on what’s going on, but until we have a better view of its implications, we are not
going to act.

Jerry Brown writes:

If it is any consolation, I don't blame you and other economists for the last recession- I blame my representatives in government, who ultimately control both fiscal and monetary policy, for allowing the recession to turn into the Great Recession. So, as an economist, don't feel too bad about those people listening (or not listening) to advice from some other economists rather than your advice. Better advice overall would be a good thing though...

Scott Sumner writes:

Thanks Marcus, I'll use that in a new post.

Alec Fahrin writes:

Marcus, I must say I am left stunned and without many intelligent thoughts after reading that transcript.

I guess no one knew what to do at the height of the financial crisis. Even the Federal Reserve.

As Mr. Rosengren said, they took a bet. The entire world financial system rested on a bet made with inconsistent information.

It is difficult to comprehend, with how the mass media has painted the elites and policy makers as geniuses, that the Fed is made of mere humans just like us.

Thankfully, after seeing the mistakes of Fall 2008, Bernanke and his allies took the bet. I'm loath to think about what would have occurred had they not.

Jake writes:

They sound like the Jedi Council from the Star Wars prequels. :p

Sit around in a circle and play "wait and see" while the world goes down in flames.

Nice post.

Thanks to Marcus Nunes for sharing the "Dream Team" bit. I hadn't seen that. I'll also post... Stunning.

E. Harding writes:

As I have repeatedly pointed out, inflation was well above target in 2011 and Trichet's policy was simply to bring inflation back to target. It was in no sense "ultra-reactionary".

Brian Donohue writes:

That's great Marcus. At September 16, 2008, the US economy was 30% of the way through the largest 5-month drop in CPI since WWII, and all that steely-eyed attention on inflation over at the Fed.

Straight ahead, I mean literally during the quarter after this Fed meeting, NGDP fell during the 4th quarter of 2008 at a 7.7% annual rate, the largest quarterly drop since WWII.

But inflation...


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