A Fed Insider puts the blame for the Great Recession square on the Central Bank´s lap.

At the AEI, James Pethokoukis just put out a comment/review of Robert Hetzel´s book: The Great Recession – Market Failure or Policy Failure?

Oh, the downturn first started with “correction of an excess in the housing stock and a sharp increase in energy prices” — the housing bust and the oil shock. Indeed, those two things were enough, in Hetzel’s view, to cause a “moderate recession” beginning in December 2007.

But only a moderate one. It was the Fed’s monetary policy miscues after the downturn began that turned a run-of-the-mill downturn into a once-in-a century disaster. Hetzel:

A moderate recession became a major recession in summer 2008 when the [Federal Open Market Committee] ceased lowering the federal funds rate while the economy deteriorated. The central empirical fact of the 2008-2009 recession is that the severe declines in output that in appeared in the [second quarter of 2008 and the first quarter of 2009] … had already been locked in by summer 2008.

Not only did the Fed leave rates alone between April 2008 and October 2008 as the economy deteriorated, but the FOMC “effectively tightened monetary policy in June by pushing up the expected path of the federal funds rate through the hawkish statements of its members. In May 2008, federal funds futures had been predicting the rate to remain at 2% through November. By mid-June, that forecast had risen to 2.5%.

And it wasn’t just the U.S. central bank. Hetzel thinks all the major central banks — the European Central Bank, the Bank of England, the Bank of Japan, sat on their hands as the global economy weakened. “The fact that the severe contraction in output began in all these countries in 2008:Q2 is more readily explained by a common restrictive monetary policy than by contagion from the then still-mild U.S. recessionHetzel writes in a Fed paper that inspired the book. “Restrictive monetary policy rather than the deleveraging in financial markets that had begun in August 2007 offers a more direct explanation of the intensification of the recession that began in the summer of 2008. Irony abounds.”

The charts below illustrate Hetzel´s “common restrictive monetary policy” argument, with major Central Banks simultaneously “dropping the spending ball”!


HT: David Lavey

5 thoughts on “A Fed Insider puts the blame for the Great Recession square on the Central Bank´s lap.

  1. The summer 2008 is one I won’t forget. It’s like one could almost feel the crash. The generally busy streets in my city were largely abandoned and the stores and malls turned into ghost towns just in the course a couple of weeks. I felt like I was living an episode of the Twilight Zone. Never seen anything like it and I hope to never see it again.
    So what do you think about Bernanke’s statement yesterday regarding micro economic suffering? Do you think he might be looking for a way out of his inflation targeting madness? He must have access to the same data the market monetarists have been floating around, and so the part about macro data masking the suffering has got to be a bunch of garbage. I don’t really understand what other conclusions can be drawn from things like the chart above. Perhaps it is just lip service, but one can only hope he is finally seeing the error of his ways.

  2. “…The general lesson is the need for a monetary rule that allows the price system to function
    through the absence of monetary shocks, not the need for the central bank to
    supersede either the working of the price system or the allocation of credit.,,”

    And a gov’t that allows that to happen too!

  3. Ridiculous. An interest rate is a price, and the Fed is practicing a form of price control. How can one claim that a interest rate of around 2% is too high when the producers of the good being priced are not willing to produce at that price? The producers with regards to bank loans and interest rates are the savers. They have not been and are not being paid enough for their production, their savings. Which is why we have had and have a terrIble savings rate. This same erroneous thinking is what made the Fed lower interest rates to near zero at the beginning of the Bush administration. In case he wasn’t paying attention that was a very bad thing to do. It reinflated the bubble and extended it into other sectors of the economy.

    I am not saying what was done now is better. It is merely a different way of inflating and with different but also bad consequences now and in the future.

    • Brian, the Fed doesn’t control interest rates by setting price controls, it controls them by changing the quantity of money, which due to sticky prices/wages temporarily changes the real rate by increasing the nominal supply of stocks and flows more than the nominal demand for them. In the long run a given change in the quantity of money only causes the fisher effect from expected inflation.

      “The generally busy streets in my city were largely abandoned and the stores and malls turned into ghost towns just in the course a couple of weeks.”

      dajeeps, that’s a powerful illustration of what happens when the medium of exchange breaks down in a capitalist society! Economists generally illustrate it by considering hyperinflation, when people don’t want to trade with the money as any inventories of it rapidly become worthless, but in a sticky-price world this scenario is just as dangerous, and far more likely.

  4. As always, excellent blogging and graphs. Is this what deceased of central bank independence have wrought? Exalted institutional mission statements and insularity?

    BTW, In modern economies, we have seen two recent “serious” bouts of inflation. Japan in the late 1980s, and the USA, late 1970s-early 1980s.

    Far from being Giant Hobgoblins, inflation was slated rather quickly. Lessons?

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