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Depression by Design: The Riot of the Rich

Simon Johnson shows just how little the elite world reads its own writing. As chief economist of the IMF, he made some useful observations about global imbalances and how excessive complacency led to the present crisis, but in his current incarnation, he is busy engaging in revisionist economic history. He says:

When he first joined the Federal Reserve’s Board of Governors in 2002, and later when he became chairman in 2006, there was little reason to expect Bernanke to revolutionize central banking. After all, it was the Age of Greenspan the Triumphant. Almost two decades of sustained growth and low inflation had created the illusion of central banking as a precise science, with the Fed simply reading economic statistics and nudging short-term interest rates up or down to keep the American economy humming and inflation low.

This simply makes no sense. Well before taking a job in the Bush executive branch, Bernanke was well known for his assertions that unusual policy mechanisms could be used in extreme monetary cases. Most famously, his assertion that the Federal Reserve could have reduced the impact of the 1929 downturn by avoiding a contraction of the money supply. Bernanke’s arguments for inflation targeting, likewise, were considered pushing the envelop of central bank practice. It is not despite these stances that Bernanke was part of the era of complacency, but because of it. He, and others, argued that since the perils of deflation could be dealt with, price stability, one of the key pillars of 1990’s neo-liberal economic theory, could be pursued with little fear for the risks. This was put forward both in peer reviewed papers in respected economics journals, and in appearances as an academic, as a member of the Bush administration, and as a member, and later chairman of the Federal Reserve. Bernanke insisted that, if necessary, we could "drop dollars out of helicopters" to increase demand. This is not a controversial reading of Bernanke’s academic CV, and that Johnson misses it is, extremely odd. Similarly, to fail to see how Bernanke’s position built on Greenspan’s is difficult to defend in the light of Greenspan’s well known interventions in the wake of the 1987 crash and the 1997-98 Asian Financial crisis and bail out of LTCM. Bernanke’s interventions are different in scale, but largely the same in mechanism: supply liquidity after a bubble has burst, but do not intervene in the assent of that bubble.

This is not, in particular, to pick on Johnson, who is offering larger analysis of the crisis on his new blog, merely to wonder at the vast rewriting of history that is going on through this particular example. Perhaps the story he tells is the one that the inside told itself, but it is not what was written. Instead there were several points in the last 30 years when very large interventions were run in order to deal with financial shocks. In the wake of the 1987 crash, a number of well known economists were gathered to talk about preventing a rerun of that event, including Marty Feldstein, Paul Krugman, and Larry Summers. Consider that on page 566 of American Economic Policy in the 1980’s, which Dr. Feldstein edited, it was noted that banks were taking on larger and larger risks, and taking larger and larger losses because of securitization. This was published in 1995, before the word CDO had it’s own shelf in the Harvard Co-op.

It is also important to see how the events of the last decade are being rewritten rather rapidly, most particularly, Iraq is being sent down the memory hole. Even economists who admit that the Federal Reserves very low interest rate policy of the middle part of the decade contributed to the credit bubble, seem to have forgotten why this was done. One part was in response to the dot com crash, but the other part was to accommodate the Iraq War. By running low interest rates, the Federal Reserve enabled an administration that wanted guns, butter, and no new taxes. This is hardly a hands off approach to central banking. Greenspan argued for administration policies, including the ill-considered tax bills of the early 2000’s and the "ownership society" which pushed home ownership.

Thus the most important proximate reason for this crisis is being overlooked entirely. It was not the fraud of banks, nor global imbalances that were the driver, but the fraud of the policy of monetizing homes to borrow money to pay for a war that would not return. If there was a ponzi scheme, the first and foremost runner of it, was Bernanke himself, who architected an economic policy which pushed for monetizing homes now, and profitizing revenue now. It is also impossible to look at the academic record and not see that the past was not one of great moderation, but of a radicalism of the right, which was confident in its ability to deal with problems laid out during the Depression by use of new tools of macro-economics.

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