Did The Fed Save The World?
I’m only part way into Ben Bernanke’s book, but I wanted to play devil’s advocate about the book’s central thesis — not to criticize BB, or question the job he did, but as a way to provoke thought about what lessons we should learn from the crisis of 2008.
Bernanke’s basic theme is that the shocks of 2008 were bad enough that we could have had a full replay of the Great Depression; the reason we didn’t was that in the 30s central banks just sat immobilized while the financial system crashed, but this time they went all out to keep markets working. Should we believe this?
It’s not a hard story to tell — and I very much agree with BB that pulling out all the stops was the right thing to do. You don’t play games at such times.
But I’m not persuaded that the real difference between 2008 and 1930-31 (which is when the Depression turned Great) lies in central bank action, or related bailouts.
It’s true that the 30s were marked by a big financial disruption; one measure (which I learned from Bernanke’s academic work) is the soaring spread between slightly risky corporate bonds and government debt:
But there was also a big financial disruption in 2008-2009, in fact comparable in size by this measure:
It didn’t last as long, but that may be as much effect as cause of the failure to experience a full-blown depression.
Why was the disruption so large despite the bailouts and emergency lending? Well, banks by and large didn’t collapse, but shadow banking rapidly shriveled up, with repo and other alternatives to bank financing shrinking very fast; liquidity for everything but the safest of assets disappeared even though the big financial firms remained in being.
And if we’re looking for effects of the tightening in credit conditions, remember that credit policy usually exerts its biggest effects through housing — and housing investment fell more than 60 percent as a share of GDP:
Even a total collapse of home lending couldn’t have subtracted more than a point or two more off aggregate demand.
So really, was putting a limit on the financial crisis the reason we didn’t do a full 1930s? Or was it something else?
And there is one other big difference between the world in 2008 and the world in 1930: big government. Not so much deliberate stimulus, although that helped, as automatic stabilizers: the U.S. budget deficit widened much more in 2007-2010 than it did in 1930-33, even though the slump was much milder, simply because taxing and spending were much bigger as a share of GDP. And that budget deficit was a good thing, supporting demand at a crucial time.
Again, Bernanke and company were right to step in forcefully. But I’d argue that the fiscal environment was probably more important than monetary actions in limiting the damage.
Oh, and since 2010 officials everywhere, but especially in Europe, have been doing all they can to undo the favorable effects of automatic stabilizers. And the result is that in Europe economic performance is at this point considerably worse than it was at this point in the 1930s.
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