It would be tempting to blame Ben Bernanke's bleak assessment of the current economic situation, in a speech in Austin, Texas, on Monday, for yet another debilitating market swoon -- the Dow closed down 679.95 points -- but it would also be unfair, even if the most precipitous portion of the plummet came after he finished speaking. As I noted earlier today, there are plenty of good solid reasons for investor despair right now, and we don't need downbeat pronouncements from the Fed chair to make us feel any gloomier. Sorry to say, but a 680 point drop in the Dow is a quite rational response to the current crisis.
Nonetheless, there was an interesting tidbit in Bernanke's speech that could inspire despair in a segment of the population that probably overlaps quite neatly with fat cat investors: the beleaguered acolytes of Milton Friedman.
On Saturday, Paul Krugman noted that Friedman's greatest contribution to the economic corpus, "A Monetary History of the United States," co-written with Anna Schwartz, argued that the Great Depression could have been averted if the Federal Reserve had moved more quickly to expand "the monetary base" (which Krugman defines as currency plus bank reserves). But Krugman observes that in this crisis, the Fed has been "spectacularly aggressive" in expanding the monetary base and so far, "it doesn't seem to be working."
(UPDATE: In the original version of this post I embarassingly confused Schwartz with Rose Friedman, Milton's wife, with whom he co-wrote "Freedom to Choose.")
"I think the thesis of the Monetary History has just taken a hit," writes Krugman.
In Bernanke's speech on Monday, he talked about the speed with which the Fed had lowered interest rates.
By way of historical comparison, this policy response stands out as exceptionally rapid and proactive. In taking these actions, we aimed not only to cushion the direct effects of the financial turbulence on the economy, but also to reduce the risk of a so-called adverse feedback loop in which economic weakness exacerbates financial stress, which, in turn, leads to further economic damage. Unfortunately, despite the support provided by monetary policy, the intensification of the financial turbulence this fall has led to a further deterioration in the economic outlook.
In other words, despite being "exceptionally rapid and proactive," the Fed's effort doesn't seem to be working.
Expanding the monetary base and lowering interest rates aren't exactly the same thing, but they are both monetary policy tools employed to goose an economy into expansionary action. So the lesson to be drawn from their simultaneous failure is identical. Monetary policy alone will not get the U.S. back on the right economic track. Massive government spending is back in fashion, as are the theories of John Maynard Keynes, whose star went into eclipse as Friedman's ascended ever higher.
And that's a topic we will be returning to in considerably more detail as the weeks go by.
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