Fighting the Last Depression: The Fed's Policy Errors

[babylonsister]

Fighting the Last Depression: The Fed's Policy Errors
By Lawrence H. Officer and Ari J. Officer Tuesday, Dec. 30, 2008

Secretary of the Treasury Henry Paulson, left, and Federal Reserve Chairman Ben Bernanke, right.

Mark Wilson / Getty


The government is fighting the current recession as if it were the Great Depression of the 1930s. This reflects a serious misinterpretation of reality, and one that will most likely persist beyond Inauguration Day.

President-elect Obama's appointment of Berkeley Professor Christina D. Romer as Chairwoman of the Council of Economic Advisors is consistent with this orientation, as she is an expert on the Great Depression and may lend support to the unwarranted focus on the Depression. Indeed, Romer has supported the Fed's current monetary policy because she sees parallels with earlier financial panics. (See who's in Barack Obama's White House.)

From this anti-Depression policy has come a stream of costly policy errors that could ultimately prolong the current recession. The Fed's December 16th decision to drop the target federal-funds rate to a record low of zero to 0.25% is but the most recent of these. With rates already effectively trading near zero despite the Fed's previous target of 1%, the decision does not actually change rates, but only sends a negative message about the state of the economy. That worsens confidence. And now the target rate has nowhere else to go, so the Fed will have to resort to new means to increase liquidity — a painful irony since liquidity is not even the problem. (Read TIME's Top 10 financial collapses of the year.)

It is true that the Great Depression of the 1930s was a crisis of liquidity. Stocks plunged, banks went under, and the value of assets disintegrated. Our current policies would have been appropriate in the Great Depression, but they are not appropriate now. Liquidity problems are not the source of our current financial and economic woes. Incredibly, excess reserves of depository institutions have increased from under $2 billion in August to a record $774 billion in mid-December, according to the Federal Reserve's December 18 release. But the banks have not taken advantage of this liquidity to increase their lending. (See pictures of the stock market crash of 1929.)

Why not? Because what we have is not a crisis of liquidity but rather a crisis of confidence. With tremendous excess reserves, it is obviously not the case that banks are not lending money because they do not have the money to loan. Instead, they are afraid that other institutions, including even other banks, will not pay it back. The banks do not have confidence in each other. Businesses, also, are not inclined to borrow money and take risks. Further, consumers are not spending because they are afraid they could lose their jobs.

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http://www.time.com/time/business/article/0,8599,1868969,00.html

[bemildred]

1. Sigh. That money is propping up all those derivatives, is what it's doing.

The banks had to meet a margin call for all those bullshit derivatives.

[MichiganVote]

2. They're all playing a bad game of poker at present. Cheating abounds.