Several decades after the “Great Depression”, Milton Friedman (with Anna Schwartz) provided a monetary explanation for the event. 80 years after the Great Depression, we came across the Great Recession. In this instance, the Fed was applauded for avoiding another Great Depression!
In 2002, Bernanke himself “apologized” to Milton Friedman, saying “we won´t do it again”.
Bernanke is “dangerous”. In January 2000, he wrote an op-ed at the WSJ: What happens when Greenspan is gone?” He could have subtitled “I will take over”. He said, however, that the Fed should adopt an explicit inflation target. Which he did. But he also “did it again”. At least in “miniaturized” form.
He had written in 1983 on “Non-monetary effects of the financial crisis in the propagation of the Great depression”. He also wrote a primer: “Monetary Policy Transmission: Through Money or Credit”.
He applied those ideas to the 2008 financial crisis. With the actions undertaken, he may have avoided a repeat of the bank blowout of 1931-32, which certainly deepened the depression. More importantly, however, if he had focused on “money”, instead of “credit”, the “Great Recession” would have not been “Great” and surely would not have been followed by a “Prolonged Depression”.
[Note: On Wednesday, September 24 2008, Bernanke wrote (Courage to Act, page 317): “Throughout the day I hammered home the argument that deteriorating credit conditions posed a grave threat. Credit is the lifeblood of our economy, I told the House Financial Services Committee. If financial conditions didn´t improve, we´re going to see higher unemployment, fewer jobs, more foreclosures…This is going to have real effects on at the lunch-bucket level”]
The best a central bank can do is provide nominal stability. The “Great Moderation” came about because, maybe by chance, the Fed managed to provide, largely, nominal stability.
It may not have been all chance. In both the December 1982 and December 1992 FOMC Meetings, for example, Nominal GDP Targeting was discussed. Snippets follow:
MORRIS. I think we need a proxy–an independent intermediate target– for nominal GNP, or the closest thing we can come to as a proxy for nominal GNP, because that’s what the name of the game is supposed to be.
Jordan: I put together a table–a big matrix of every forecast for as many quarters out as the Greenbook does it–for every meeting for the last year. What struck me was that it looked as if we were on a de facto nominal GNP target. When nominal GNP is at or above expectations, the funds rate is held stable; but when nominal GNP comes in below what has been expected, we cut the funds rate.
Greenspan (in closing):
As I read it, there is no debate within this Committee to abandon our view that a non-inflationary environment is best for this country over the longer term. Everything else, once we’ve said that, becomes technical questions.
… I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that.
NGDP Targeting was also discussed during Bernanke´s tenure. In The Courage to Act, we read (pps 515-19):
With substantial new securities purchases and balance sheet expansion unlikely to win the Committees support in the near term, it was once again time for blue-sky thinking. I had been discussing a wide range of monetary policy options internally since the previous summer (2011). The conversations continued through 2011 and into 2012.
…A more radical idea, supported by many academics, was called nominal GDP targeting. I had discussed it with Don Kohn, Janet Yellen and Bill Dudley before launching QE2 in 2010.
Bernanke goes on to show he has no understanding of what NGDP targeting means:
Under nominal GDP targeting, the central bank no longer has a fixed inflation target. Instead, when growth is strong, it shoots for lower inflation. When growth is weak, it seeks higher inflation…
To him, as an ardent inflation targeter, everything is understood in terms of inflation! He doesn´t understand that NGDP Targeting (level targeting) simply means that you will try to keep NGDP evolving along a stable level path. There´s no “shooting for lower or higher inflation”.
The full FOMC would discuss nominal GDP targeting at its November 2011 meeting.
…After a lengthy discussion the Committee firmly rejected the idea…For nominal GDP targeting to work, it had to be credible. That is, people would have to be convinced that the Fed, after spending most of the 1980s and 1990s trying to quash inflation, had suddenly decided it was willing to tolerate higher inflation, possibly for many years…
Bernanke confirms he´s clueless about what nominal GDP targeting entails because he goes on to say (again, mistakenly, couching the argument in terms of inflation):
But what if we succeeded in convincing people inflation was headed higher? That outcome, too, carried risks. Would people trust that future policymakers would have the courage and competence to quash inflation later, as the strategy dictated, even if doing so risked creating a recession? If not, nominal GDP targeting could increase fear and uncertainty about future inflation…Then the Fed could eventually find itself in a 1970s-style predicament – without credibility and with the economy suffering from low growth and too high inflation.
Not understanding what nominal GDP targeting means, he writes:
An idea related(!) to nominal GDP targeting, but far easier to communicate, was simply increasing our inflation target to, say, 4 percent – without the commitment inherent in nominal GDP targeting to later bring inflation very low…
Bernanke is really an inflation-targeting freak! Note than in 1982 or 1992, no one said that by targeting NGDP, the Fed “had suddenly decided it was willing to tolerate higher inflation, possibly for many years”. And just two months after this discussion, in January 2012, the Fed made the 2% target official policy!
The fact is that during Bernanke´s tenure at the Fed nominal stability was lost. Just as high/rising inflation – a “Great Inflation” – is the outcome of losing nominal stability in one direction, a “Great Recession” is the outcome when nominal stability is lost in the opposite direction!
As I´ll also show, just by recouping nominal stability, but keeping it at the low level attained after it was dumped during the “Great Recession”, leads you to the “Long Depression” in which we have been living for the past seven years. In other words, there was never a recovery following the “Great Recession”, only an “underwater” expansion.
The panel below depicts
1 a period of nominal instability from a rising NGDP growth trend, resulting in rising inflation and volatile real growth (top chart),
2 a period of nominal stability at an adequate trend level path of NGDP, resulting in low & stable inflation and robust but stable real growth (middle chart) and
3 a period of nominal stability at a “too low” trend level path of NGDP, resulting in low & stable inflation and low but stable real growth (bottom chart).
The monetary story I will tell, explains how the economy went from the middle chart to the bottom chart, in other words, how it got stuck in a low nominal & real growth environment, remaining, in fact, depressed.
The monetary variable I use is the broadest measure of the Divisia Monetary Index provided by the Center for Financial Stability. The monthly GDP (nominal & real) are from Macroeconomic Advisers.
To maintain nominal stability, the Fed has to offset changes in velocity, according to MV=PY or, in growth form, m+v=p+y. Let´s check from 2004 onwards. (We know, from looking at the middle panel of the chart above, that nominal stability prevailed for much of the time at least since 1992).
Beginning soon after Bernanke becomes Fed Chairman in January 2006, velocity begins to fall (money demand growth to increase). Money supply growth only offsets this partially, resulting in a slowly falling NGDP growth.
In mid-08, still three months before Lehman, velocity shoots down. Money supply initially barely budges and then falls. NGDP growth becomes significantly negative. That´s the “Great Recession” part.
In mid-09, just as the GR comes to an official end, Divisia M4 velocity growth rises significantly. Now, money supply growth offsets it only partially, allowing NGDP growth to rise. From that point on, nominal stability is regained, albeit at a lower level of NGDP growth, implying a lower level of real output growth.
The result was that, by not allowing NGDP to climb back to its previous trend level after the original mistake made by the Fed, the “Great Recession” morphed into a “Long Depression”.
As the charts below indicate, by letting the money stock permanently fall, the level of nominal spending was permanently reduced, as was the level of real output.
It is, therefore, not at all surprising that inflation remains “too low”, and long-term interest rates do not go higher despite all the Fed´s threats to “normalize” monetary policy. In fact, by insisting on “normalizing” policy, the Fed will likely reap recession!