Another Look at What Caused the Great Recession

 

Federal ReserveDavid Beckworth and Ramesh Ponnuru take to the pages of the New York Times to explain concisely why it was a tight-money error by the Fed, not the burst housing bubble, that deserves ultimate blame for the Great Recession. If an op-ed isn’t concise enough for you, here is Beckworth from a chart-laden blog post:

To summarize, our argument is that the Fed was doing a decent job responding to the housing bust up until 2008. After that point it tightened monetary policy and catalyzed the reaction that lead to the Great Recession. By the time the Fed changed course in late 2008 it was too late. Interest rates had already cross the zero lower bound (ZLB). Once that happens monetary policy as it is currently practiced cannot do much.

I have blogged quite a bit about this. Of course one doesn’t have to fully buy this market-monetarist take to accept the idea that a more aggressive Fed, earlier, might have at least prevented the worst of the downturn. A bad recession, perhaps, instead of a Great Recession and Financial Crisis. Active monetary policy has a role in dealing with economic shocks — say, a simultaneous surge in oil prices and bursting of a subprime mortgage bubble. Here B&P sum up:

We could have had a decline in housing without a Great Recession. That’s what we went through for two years. What we could not have had without a Great Recession was a decline in nominal spending. If it had cut rates faster, or merely refrained from talking up future rate increases, the Fed might have kept that decline from happening or at least moderated it. Australia had a housing boom and debt bubble, too, but kept a steadier monetary policy. The consequence was a mild correction, but nothing like our Great Recession.

It took decades for the Fed’s responsibility for the Great Depression to be widely accepted and it may take that long for most people to see its responsibility this time around. The Fed of 2008 feared inflation too much and recession too little. It placed too little weight on market expectations about future conditions and on how its behavior affected those expectations. If these mistakes go unrecognized, they could well be repeated.

Published in Economics
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  1. I Walton Member
    I Walton
    @IWalton

    So sub prime mortgages, securitization of same, leveraging those semi worthless assets, over building and overbuying real estate, dumping slum housing by getting renters to take out mortgages they  could walk away from,  all  kept rolling by the Fed, Fanny and Freddy, and incentives that led Financial institutions to embrace it all with little or no personal risk, had nothing to do with it?  It’s just that the Fed should have kept the fraud rolling for a few years longer?   Let’s not try to unlearn what we learned from this unnecessary government and Fed caused disastrous episode of corruption and innate government ineptitude and hubris.

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  2. Joseph Eagar Member
    Joseph Eagar
    @JosephEagar

    Could the Fed really have done more?  The U.S experienced  a miniature balance of payments crisis.  The only way the Fed could have loosened policy beyond what it ended up doing would have been a sudden, sharp devaluation.  That might have bought a few more months, perhaps a year, but then we would have been straight back where we started.

    BOP crises are caused by too much demand, not too little.  What the U.S. most needed in 2009 was a structural devaluation, and that’s what we got.  The Fed kept inflation in positive territory, the government cut back (after the 2010 election), and the result was gradually falling wages (which have recently begun to rise now that the adjustment is over).

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  3. inmateprof Inactive
    inmateprof
    @inmateprof

    Wow, so the fed should have continued this insanity? Forgive me, I may just be a rube, but I cannot believe that the idiocy by the consumers that was supported and paid for and then bailed out by the government could have been fixed by the Fed Chairman if he pulled the levers just a little harder.

    That sir, is some dismal science

    • #3
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