Tuesday, January 5, 2010

Bernanke’s Speech

Ben Bernanke – Chairman of the Federal Reserve – made a speech the other day.

Nothing unusual about that.

What was unusual is that he made it at the annual meetings of the American Economics Association – so the audience was all experts. Ideally, this would make it more thoughtful.

This is a good point to mention a bunch of issues related to what was in the article.

First, there is Bernanke. Many blame him, in part, for the economy’s problems. This has died down a bit, and it now looks like he will get a second term. We have had Fed chairmen before who goofed things up: I’m not sure Martin knew what he was doing, and Miller was a bowed to politics over economics. It’s possible that Bernanke is part of the problem, but this doesn’t seem likely. He isn’t known for jumping to rash decisions. He is known for being demonstrably smarter than just about everyone else. He had Fed experience before taking the job. He had executive experience before taking the job. And … he’s probably the premier living expert on how badly monetary policy was conducted during the Great Depression. Other people might do a better job, but they sure won’t look like better applicants for it.

Some people also blame his predecessor Alan Greenspan. This is funny, since the world spent almost 20 years idolizing his performance. Either his critics were lying to themselves and others then, or they are just being jerks now. This is kind of like criticizing FDR as a president; you can do it, but it’s a stretch, and you’ll probably end up sounding like a hack.

There’s also been a lot of criticism of the Federal Reserve – from both the left and the right. The upshot of most of this criticism is a call for more political oversight of the Fed. This is in spite of the fact that economists spent most of the last 30 years researching how the political independence of central banks was strongly related to positive economic performance. This led dozens of countries to distance their banks from their governments, in imitation of the central banks in the U.S., Germany, Switzerland, the U.K., and New Zealand.

All of these criticisms are worth listening to, and considering seriously. But, I think any serious consideration of them should start with the reasons why we should reject all of the past research on these issues. Think about it: when was the last time you heard a pundit mention that Bernanke was not the best man for the job when it was open, that everyone must have been wrong to think that Greenspan should be reappointed 3 times (by Democrats and Republicans), or that the Federal Reserve needed tighter control because the economy wasn’t vibrant enough the last 25 years?

Now, this article discusses how Bernanke specifically combats the assertion that the financial crisis was caused by interest rates that were too low under Greenspan. Instead, Bernanke cites lax financial regulation, mostly by other agencies.

Not surprisingly, Bernanke’s assertion paints him and the Fed in a nice light. On the other hand, he wasn’t booed by an audience full of people well-versed in both arguments.

I’m not going to take too strong a position on this – it’s early in the semester, but it’s also early in the post mortem of the Great Recession. I will point out that most of the macroeconomics books used at the principles level have large, and increasing, treatments of the lax oversight of government sponsored entities involved in financial regulation. This stuff started showing up in books 15 years ago, so it isn’t like the experts didn’t see problems coming. Also, the financial bubble has never seemed to be nationally even, and its easier to see how regulation could vary by location than it is to argue that Fed policy varied by location.

And … I want to stay somewhat non-committal on low interest rates. Maybe we’ll decide that was a problem when all the numbers are in. For now, though, I am highly suspicious of this position. For my part, it falls too neatly into the common argument that things would have been better if only we’d been harder on ourselves earlier. This is a moral position that people have been pushing for thousands of years, and there isn’t a lot of empirical support for it: that’s why it is couched as a moral rather than an empirical argument. But … economics is about data, and without a lot of other financial systems that blew up because of low interest rates, I tend to think this viewpoint is not very strong.

Lastly, I’ll add a seldom mentioned point. If the low interest rate as a cause story is true, then we are in for some very rough times ahead. The reason is that low interest rates are indicative of loanable funds swamping viable projects that people might borrow to finance. Why on earth would this be happening? Well, first off, the world is filthy rich in ways we couldn’t imagine in the past. So, there’s a lot of money out there. Second, a lot of that money is coming from places like China and Arab countries, who don’t have societies that generate a lot of viable projects. So, there money comes here. Neither one of these is going to go away. So, low interest rates won’t either. Thus, if you take the low interest rates as a cause argument seriously, the future looks like one of common and severe financial crises. To me, this doesn’t seem plausible.

Read up on this in “Lax Oversight Caused Crisis, Bernanke Says” in the January 4th issue of The New York Times.

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