The Wall Street Journal is on the hard-money side of the debate over recent monetary policy. But its editorial on the departure of Ben S. Bernanke as chairman of the Federal Reserve articulated a conventional wisdom that transcends that debate.
The consensus assessment is that the Fed under Bernanke’s leadership kept interest rates too low during the boom years of the last decade, which contributed to the financial crisis, but when the crisis hit, the Fed’s heroic efforts staved off a reprise of the Great Depression. The Journal allows that time will tell about the post-crisis policies, but expresses skepticism.
There’s another view of the Fed’s role in the crisis, though, that has been voiced by economists such as Scott Sumner of Bentley University, David Beckworth of Western Kentucky University and Robert Hetzel of the Richmond Fed. They dissent from the prevailing view that the Fed has been extremely loose since the crisis hit. Instead, they argue that the Fed has actually been extremely tight, and that when its performance during the crisis is measured against the proper yardstick, the central bank emerges as the chief villain of the story.
In the second half of 2008, housing prices, many commodity prices, inflation expectations and stocks all suggested deflation was coming. Fed officials, though, kept talking about backward-looking measures of inflation that made it look high. Their hawkish pronouncements effectively tightened monetary policy by shaping market expectations about its future direction. In August 2008, the Fed minutes explicitly said to expect tighter money. Even after Lehman Brothers Holdings collapsed the following month, the Fed refused to cut rates and fretted about inflation (which didn’t arrive). A few weeks later, the Fed decided to pay banks interest on excess reserves, a contractionary move. Only then did it cut interest rates.
During the years of the “Great Moderation,” nominal spending (the size of the economy, measured without adjusting for inflation) had grown at a fairly steady rate. During the crisis, the Fed provided no indication that it would exert itself to continue that trend – and nominal spending started to fall at the fastest rate since the Great Depression. Lower expectations of future spending and income made for lower asset prices and higher debt burdens, adding to bank losses and making households less likely to consume and businesses less likely to invest. Another way of putting it is that the Fed increased the monetary base by enough to offset the financial industry’s troubles, but not by enough to offset the decline in velocity.
Bernanke’s Fed could certainly have done worse. It wasn’t as tight as the Depression-era Fed, or as the European Central Bank. But its mistakes made the crisis much worse and the recovery much more sluggish than it could have been. Bernanke doesn’t deserve all the blame for this performance – he may have been constrained by his colleagues or by the overall political environment – but he hasn’t acknowledged what the Fed got wrong, and neither have most of the pundits commenting on his legacy.
This analysis, again, is far from the conventional wisdom. But there is a precedent for that. In the early 1930s, many people worried that the Fed was being too loose, and only decades later did it become clear to almost everyone that it had really been too tight. Eventually, we may revise our view of the Bernanke era in the same way.
Ramesh Ponnuru is a Bloomberg View columnist, a visiting fellow at the American Enterprise Institute and a senior editor at National Review.