David Beckworth, with Romesh Ponnuru, makes the NYT.
It took a bigger shock to the economy to bring the financial system down. That shock was tighter money. Through acts and omissions, the Fed kept interest rates and expected interest rates higher than appropriate, depressing the economy.
In a way, this is an easy argument to make.
1. A recession is, almost by definition, the economy operating below potential.
2. Operating below potential is, almost by definition, a shortfall in aggregate demand. The only other type of adverse event is a supply shock, which reduces potential but does not force the economy to operate below that reduced potential.
3. The Fed controls aggregate demand.
4. Therefore, all recessions are the fault of the Fed. Either by commission or omission, the Fed has messed up if we have a recession.
It is an easy argument to make, but I believe close to none of it. I do not believe in the AS-AD framework. And I do not believe (3). If you do not know why I have my views, go back and read posts under the categories “PSST and Macro” and “Monetary Economics.”
My view is that the housing boom and the accompanying financial mania helped hide some underlying adjustment problems in the economy. The crash, the financial crisis, and the response to that crisis all helped to aggravate those underlying adjustment problems. I suspect that, on net, the bailouts and the stimulus diverted resources to where they were less useful for maintaining employment than would have been the case if the government had not intervened. My basis for this suspicion is my belief that people who do not need help are often more effective at extracting money from the government than people who do need it.
There has been much other commentary on the op-ed–see Scott Sumner’s post.
“My view is that the housing boom and the accompanying financial mania helped hide some underlying adjustment problems in the economy. The crash, the financial crisis, and the response to that crisis all helped to aggravate those underlying adjustment problems.”
This is exactly and precisely where I’m confused as to your exact views. The mainstreamers think the economy is the economy. It’s just GDP, which is just activity. Here you are making a distinction between the activity and something real, something far more real than just “activity minus nominal inflation.” That is what I think you consider the “sustainable” part. Mainstreamers don’t seem to make such a distinction. So, what you call “hiding” they call stimulus, because they don’t make this distinction. But in other posts you seem to insinuate that you don’t even think the “hiding” function is effective.
“I suspect that, on net, the bailouts and the stimulus diverted resources to where they were less useful for maintaining employment than would have been the case if the government had not intervened.”
Suppose instead the Federal Reserve had done as Beckworth and Ponnuru suggested and loosened monetary policy sooner than it did.
Would that have prevented the economy from diving steeper and sooner than it did, and giving the market more time to re-adjust for the mismatch in PSST you identify? If so, wouldn’t that be a better outcome than the subsequent bailouts and stimulus, which, as you say, probably moved wealth into the wrong hands?
Or would you say that the looser monetary policy would have had the same ill-effects that the bailout and stimulus did? If so, why?
How early? Like 2002? A little Fed Funds rate humor.
” And I do not believe (3).”
I can understand why you would be skeptical that the Fed could affect the Y in aggregate demand, but surely you can’t be doubting the Fed’s ability to ratchet up P to whatever level it wants?
Prepare to have your mind blown!
Let’s say The Fed wants $5/gallon gas. Do you th8nk they can nail it?
Likewise, what if the real growth rate is 1% and The Fed targets 5%. From what I can tell the MM answer is something like “if they target 5% then real gdp growth would not in fact be 1% with really high 4% inflation relative to growth.” Do you see the problem?
Asset prices, credit and debt add inertia to the economy that is not captured in standard models which reduces the control of the Fed, and zero bound and institutional biases reduce it further, but I don’t buy the diversion of resources an iota. Sure those who need less help are more effective at extracting it, but that is always the case and more the case ordinarily. Recessions are marked by floods of resources for which no use exists. Unemployment, inventories, interest rates, are all symptomatic of this. The largest mistake those from an Austrian background make is the confusion of money with resources and that money is finite and precious when all it is is an accounting.
Like all good stories you take one lie and build a bunch of truths around it. The lie here has several good candidates, but I think this one is the best (worst)
“It took a bigger shock to the economy to bring the financial system down. That shock was tighter money. Through acts and omissions, the Fed kept interest rates and expected interest rates higher than appropriate, depressing the economy. This point is easy to miss because the Fed lowered interest rates between September 2007 and April 2008. But raising rates is not the only route to tighter money.”
Market monetarists are fond of telling us that we need to use expected inflation (in the absence of nGDP markets of course) to determine Fed tightness/looseness. From September 2007 to April 2008 the Fed lowered interest rates. What were inflation expectations during that span? The 10 year TIPS spread dipped a hair below 2.2% in September and rose to 2.45% in November. The Fed continued to lower rates through April (with EI dipping and then rising again to 2.5%).
If a MM had been in charge of the Fed with a 2% inflation target, to be consistent with their claim that they would have loosened in August/September 2008 they have to admit that they already would have been tightening earlier than the Fed actually did. In essence the Fed made better decisions (according to MMs) than MMs would have in the year or so prior to the crises.