A monetarist's prescription for what ails the economy...

[JeffB]

The following was from a post on a thread I had started in asking for info about the Great Depression and business cycles prior to the institution of the Federal Reserve. I thought it was wandering a bit off topic and might warrant it’s own thread:

@Wilmot of Rochester

@Jonathan M. F. Catalán

I’m surprised America’s Great Depression hasn’t been linked. Best source on the first four years of the Great Depression, and what caused it; for one thing, it disproves Friedman’s thesis that the Federal Reserve sat inactive after the crash. Although not dealing with the 1929 crash (1937 recession, instead), I outline Rothbard’s argument here: The Dangerous “Lessons” of 1937.

The Federal Reserve responded to the bank’s loss of liquidity after the original crash of October 1929 by shoring up bank reserves by adding roughly $300 million to the money supply by November of that same year. Between October and December controlled reserves had risen by $359 million, while uncontrolled reserves had fallen by $381 million. As a result, there was an estimated $21 million decrease in bank reserves for the first three months of the Great Depression. 1930 saw the beginnings of an even greater inflationary process, with the New York Federal Reserve reducing the rediscount rate from 4½% in February 1930 to 2% by the end of that same year. However, again, despite the Federal Reserve’s inflationary measures, the money supply fell by roughly 250 million dollars.[9] Although the Central Bank continued in its effort to pump money into the system it failed in its efforts to create more money than was being lost through the decline in uncontrolled reserves, meaning that throughout 1931 and 1932 there was still a decline in the money supply. The claim that the Federal Reserve did nothing to counteract the deflating effects of the bust bases its factual evidence on the general decrease in the volume of the money supply. Monetarists need to take a closer look at the history of the United States’ money supply during this era, and need to account for why the decrease in the money supply was so gradual.

I’m pretty sure Rothbard uses misleading statistics here.

I’d point to the interview on EconTalk with Scott Sumner.

[JeffB]

@Wilmot of Rochester

@JeffB

In our current situation I don’t think the Fed can be accurately accused of “inaction” in the face of a shrinking money supply. In fact they’ve been very active in trying to counteract the shrinkage due to the deleveraging that naturally follows a massive run-up in debt, itself a natural concomitant of a massive ongoing increase in the money supply.

I personally think that is a problem in itself and likely to make things worth in a later reckoning which may be put off for a time, but at a price of a more severe adjustment when it inevitably is forced upon us. But that’s speculation on my part, of course. I imagine we’ll find out in due time.

I just put a link to an interview with Scott Sumner on this. They haven’t really done as much as many of the people here would suggest, at least according to Sumner.

I listened to the podcast you linked to and although I enjoyed listening to Mr. Sumner’s views he hardly sounds like an Austrian economist, his self-described libertarian leanings to the contrary notwithstanding. It doesn’t sound like he’s accusing the Fed of inaction, however, but rather that he’s advocating much more action by them. In fact, it sounds like he’s advocating an open ended mandate for them to do “whatever it takes” to achieve a stable GDP growth target. In this particular case he feels that a zero interest rate policy and a doubling of the monetary base was too little too late to achieve those goals. He feels those goals were attained during Greenspan’s golden years of “The Great Moderation” and Bernanke dropped the ball by allowing nominal GDP to contract rather than to continue expanding at that steady target rate forever. He’s mentions a 5% target rate with a 2% annual inflation rate, though he wouldn’t be averse to alternatives such as a 3% nominal GDP growth rate target with 0% inflation.

Although I think his proposal is unique and sounds good, I think that it would be an experiment on our economy on a grand scale and a major gamble at best. I personally would be open to trying it, if this were some sort of video game where we could hit a “replay” button if things blew up in our faces, but I think the stakes are too high and consequences too severe to play that game in real life.