Bernanke misses the “heart of the matter”

Bernanke said of the Great Depression in his third Lecture at GWU:

First, the Fed failed to use monetary policy to prevent deflation and an economic collapse. Second, the Fed did not adequately carry out its responsibility as “lender of last resort,” even as thousands of banks failed. ”The Fed did not fulfill its intended mission” during the Great Depression.


Without the forceful policy response that stabilized the financial system in 2008 and early 2009, we could’ve had a much worse outcome in the economy. Without strong government intervention the financial system could have faced a “total meltdown.”


Even as the crisis ebbed, the recession deepened, with gross domestic product shrinking at an 8.9 percent annual rate in the fourth quarter of 2008, the worst quarter in 50 years. The unemployment rate rose to 10 percent in October 2009, the highest since June 1983. The threat of a second Great Depression was very real.

You can see that Bernanke implies that this time “we did it right”, and avoided a catastrophe because our intervention was “forceful and stabilized the financial system”.

He simply won´t recognize the responsibility the Fed had in turning a “normal” recession into a “Lesser Depression”. The economy only plunged after mid-2008. By then the house bubble had popped more than two years before and financial problems had appeared since early 2007 and intensified some months later.

There were two things in his mind. His “creditism” bias geared his “save the financial system” actions, while his inflation target bias geared his monetary policy actions, which in practice, because of the “threat” of rising oil and commodities, turned strongly contractionary in mid-2008. How do we know that?

In words: When the financial crisis became noticeable in early 2007, money demand immediately increased (velocity fell). If money supply had not risen, nominal spending (NGDP) growth would have contracted. But money supply rose to accommodate money demand so nominal spending kept chugging along. Unfortunately, since early 2008 the FOMC became very worried about the possibility of inflation and inflation expectations becoming “unmoored”. And that remained the FOMC´s sentiment all the way through the September FOMC meeting, which took place AFTER the Lehman affair! The practical consequence of that “worry” was that although velocity continued to fall, money growth retrenched. With MV falling PY would also fall, a “no brainer”.

End result: The banks were “saved”, but workers were “doomed”! So no, Bernanke is no “Hero”, as the Atlantic Magazine tries to portray.

3 thoughts on “Bernanke misses the “heart of the matter”

  1. Marcus – if you believe there was a housing bubble, then what responsibility do you allocate to the Fed for this development? Bubbles always involve easy monetary policy, and are always in history followed by difficult periods after they burst – I do not believe there has been a single case of central bank activity preventing any pain from developing. Deferring perhaps, but not eliminating it.

    I personally would say that we had a credit bubble, and not a housing bubble – they are slightly different things.

    • CB – With regards to this point, David Beckworth and Josh Hendrickson and non MM´s like John Taylor, put a lot of the blame on the Fed (“too low for too long”). Scott Sumner and I do not see the Fed as playing a relevant role in the “bubble affair”. As I´ve argued several times, MP was NOT easy in 2002-04. It was what was required to bring NGDP back to it´s trend level, which it did by the end of Greenspan´s tenure in late 05.

  2. Should the Fed be responsible for weak commercial and residential underwriting standards? If banks allow borrowers to heavily leverage to buy real estate, on dubious appraisals, the Fed should starve the economy?

    Nunes is right-on in this blog. The Fed saved the banks, then pulled in its horns–right when it should have gotten very bullish.

    Richard “Inspector Clouseau” Fisher was, per his habit, exactly wrong.

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