Second-Guessing Bernanke in the 2008-09 Crisis

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Gretchen Morgenson’s (2015) New York Times column, “At the Fed in 2009, Rolling the Dice in a Crisis”, is a noteworthy take on the 2009 transcripts of Fed meetings during the most perilous economic crisis since the 1930s depression. She illustrates issues that will be of interest to readers of the GEM Project’s weekly blog. Her interpretation has three parts. First, she calls attention to the debate that we already knew was on-going in the FOMC. “There were two basic camps within the Fed. On one side were the Reserve Bank presidents who wanted to throw anything and everything at the crisis. For the most part, these officials came from regions — like New York and Boston — that are home to big financial firms. They contended that the financial system was in such peril that big substantive action had to be taken, pronto. On the other side were those who hoped to weigh the trillion-dollar programs — separately and together — to make sure their costs and risks didn’t exceed their benefits. Many holding this view were from regions with more diverse economies, like Kansas City and Dallas.”

Second, she praises the District Bank Presidents who argued for the more carefully calibrated approach to dealing with the imploding crisis. The ‘diverse-economy’ District Bank Presidents “objected to the ad hoc nature of the rescues. These people, quite rationally, wanted a cost-benefit analysis of the proposals to ensure they would generate real results while limiting downside exposure.” Most of her readers, probably unfamiliar in extreme-instability macroeconomics, likely agree with Morgenson and the FOMC minority. How can the attempt not to do too little or too much be wrong?

Third, she reformulates the argument that she has frequently made during and since the 2007-09 Great Recession: The primary purpose of the Fed’s crisis-management programs was to rescue banks from the consequences of their risky, irresponsible behavior, putting taxpayers and the rest of the economy at great risk. “[Those] who raised questions about the potential costs and benefits of the 2009 programs had good reason to. As the transcripts indicate, their concerns were at least in part intended to protect the larger economy from the perils of rescuing reckless market participants.” She criticizes Fed estimates of the cost of Bernanke’s successful stabilization programs for understating “the risk that the Fed took by being willing to bring dubious securities onto its balance sheet and the true costs of lending money against them.”

Morgenson does not mention that the cost-benefit camp was a small minority on the FOMC, each of whom had originally failed to recognize the severity of the crisis. But mostly she misleads her readers less intentionally. Simply put, she understands neither the nature of the macro disruption that was unfolding in 2008-09 nor what Bernanke was doing to save us from its consequences. His strategy featured three principles rooted in his careful study of the 1930s depression, an unparalleled economic crisis about which the Fed Chairman had a far better grasp than his FOMC critics. In 2009, he understood what was necessary; the FOMC minority calling for cost-benefit analysis did not.

First, the proper stabilization goal must be the use of the Fed balance sheet to intervene in a range of markets, wherever would be useful, to halt and reverse the collapse in total spending actually occurring in the economy. Any other objective conflicting with or detracting attention from the crucial total-spending goal must be rejected.

Second, programs in support of the total spending goal should be very aggressively sized and executed with maximum speed. Bernanke’s mantra was: there is no program too big or too fast. Morgenson does not understand that size and speed were essential. She does mention that there was not much time to do the careful analysis that would balance costs and benefits. That is both true and irrelevant. She misses the point that attempting to optimize via a cost-benefit exercise is a fundamentally wrong strategy. By its nature, the fine-tuning approach could easily be incorrect. Here’s the rub. If it fails to do enough to halt and reverse the collapse in total spending, policymakers get no second chance. There are no Mulligans. Trying not to do too much, with its relatively trivial benefits, accepts the tragic risk of dooming the economy to a 21st century depression that would generate unimaginably huge losses. Bernanke understood, and Morgenson does not, that the expected losses inherent in such a roll of the dice are unacceptable.

Third, a substantial part of the Fed’s stabilization effort, to be effective, had to focus on the financial system. That system plays a crucial role in the macrodynamics of aggregate demand, i.e., recycling saving into spending. The Fed was properly directing remedial policies where they would be most effective in stabilizing the economy, not to prevent losses for banks’ leadership or shareholders.

From the perspective of the GEM Project, Bernanke’s strategy was the single promising approach “to protect the larger economy” from the destruction of depression. The argument of the few District Bank Presidents for cost-benefit analysis would have exposed the US economy and its millions of households to an unacceptably high risk of destruction of their living standards. Her praise for the cost-benefit group within the FOMC reveals Morgenson’s inadequate understanding of what was happening in 2008-09 and what needed to be done. If she wants to clear up her confusion and become a more responsible interpreter of stabilization policymaking, she could read Chapters 5 (Bernanke’s depression model) and 6 (macroeconomics of extreme instability) in the eBook available on this website.

Blog Type: Policy/TopicalSaint Joseph, Michigan

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