Eichengreen: There are dangers embedded in persistent stability

In today´s (Jan 10) Upshot, Neil Irwin comments on Eichengreen´s “Hall of Mirrors – The Great Depression, the Great Recession and the uses – and misuses – of History”, with the title “The Depression’s Unheeded Lessons”:

The global economy stood on the precipice, making the possibility of a descent into the horrors of the Great Depression — the despair our grandparents told us about — all too real. Then some brave leaders with a knowledge of history and names like BernankeGeithner and Paulson (or if you have an international bent, TrichetKing and Darling) stepped in, applied the lessons of that brutal period and pulled us back from the abyss.

That, anyway, is the oversimplified history of the crisis of 2008 that has become commonly accepted thanks to book-length journalistic narratives(one of which I wrote) and the memoirs of several major officials involved. To the degree that these officials are faulted, it is usually for the large budget deficits or multitrillion-dollar central bank balance sheets that resulted from years of interventionism and still haunt us.

Now one of the world’s leading economic historians, Barry Eichengreen, has come forth with an alternate view: Rather than hoist anyone to our shoulders for preventing another Depression, we should be more clear-eyed about the ways in which global leaders did not really learn the lessons of the 1930s at all and made many of the same mistakes as their Depression-era counterparts.

The book provides a detailed account of the recent economic history. And, therefore, is very useful and interesting.

Nevertheless, I take serious issue with some of Eichengreen´s conclusions, in particular the view that “persistent stability is likely bad for financial (and economic) health” Page 379):

…Modern-day policymakers learned from the mistakes of their predecessors. Scientific central banking informed by a rigorous framework of inflation targeting reduced economic and financial volatility and prevented serious imbalances…

This belief, we now know, was dreadfully wrong. The economic and financial instability of the 1920s and 1930s may have been heavily associated with inflation and deflation, problems that inflation targeting, the twenty-first-century version of Friedman and Schwartz´s stable money growth rule, could plausibly claim to have solved. But this did not mean other risks to stability were eliminated. To the contrary, the long period of economic stability, the Great Moderation, encouraged investors to take on additional risk…time dampened awareness that financial markets are unstable…All this suggests that the longer the period of stability persists, the greater the risks. But this is not the perception while the party is underway.

The first thing to note is that there was never something that could be construed as “rigorous framework of inflation targeting”. In fact, it could well be argued that for a long period before the crisis hit, both inflation and non-inflation targeting central banks were de facto practising NGDP Level targeting (Which is more reliable). If that was the main factor behind the nominal stability that characterizes the Great Moderation, it´s loss could do damage. Indeed, it was lost “in spades”.

I reproduce below two charts from my previous post that show how the “crack” in the basic macro-foundation (nominal stability) “unleashed hell”.



Furthermore, I feel there´s something very wrong with the argument that persistent stability is something “bad”. The natural “solution” would be to devise policies that have the power to “surprise” once in a while in order to keep “investors on their toes (or guessing)”.

Keeping the economy “depressed” may be just such a solution.

4 thoughts on “Eichengreen: There are dangers embedded in persistent stability

  1. I understand the Hyman Minsky-esque idea that steady growth leads to risk-taking.

    So what? When a loan fails, money is not lost in a macroeconomic sense.

    If the central bank steadies NGDP growth, then some loan failures do not mean much. (Of course, steady NGDP growth in itself would tend to reduce loan failures).

    The Hyman Minsky idea, along with the “low interest rates are bad” ideas, rest on a premise that free markets are inherently unstable to due to the terrible decisions investors and business operators and lenders will make en masse given slight provocation.

    Well, okay, if that is true, then we should just agree to central planning and be done with it.

  2. Quite a good, and big, review of Eichengreen’s book in the FT on Saturday. Picks out good lessons from the Great Depression, that it was monetary and not fiscal solutions that got the US back to work. It also treats well his criticism of the Euro. That won’t go down well in the Chancelleries of the old continent.

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