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 Economic Freedom
 
Did Ben Bernanke and the Fed save us from another Great Depression?
Christian Science Monitor, United States Thursday, September 17, 2009

George Selgin
Even a severe downturn can be followed by rapid recovery without aggressive central bank intervention. In the 1921 recession, wholesale prices, industrial production, and manufacturing employment all fell by 30 percent or more within a year. Yet by early 1922, the US economy had recovered fully from its mid-1921 low. What's more, it did so with no help from the Fed, which was determined to let the recession take its course, so as to hasten the restoration of the prewar gold standard. The current recession is probably over, said Ben Bernanke this week. His timing is exquisite. But did his Fed have a role, asks George Selgin in the Christian Science Monitor.

Athens, Ga. - The recession is probably over. So said Ben Bernanke this week. His timing is exquisite. President Obama has reappointed him to be Fed chairman, and he can now head into his Senate confirmation hearings this fall with the reputation that he nipped another Great Depression in the bud.

But did he?

... ... ...

Recessions don't peter out in 10 days, of course. But they do eventually end, with or without central bankers' help. According to the National Bureau of Economic Research, the US went through 32 recessions between 1854 and 2001, the average duration of which was about 17 months – or a few months shorter than the current recession, so far.

Even a severe downturn can be followed by rapid recovery without aggressive central bank intervention. In the 1921 recession, wholesale prices, industrial production, and manufacturing employment all fell by 30 percent or more within a year.

... ... ...

Until the late summer of 2008, the Fed responded to what was really a solvency crisis as if it were a liquidity crisis, establishing the Term Auction Facility in December 2007 and dramatically lowering its interest rate target. Yet while it was taking these steps, the evidence pointed not to a liquidity shortage, but to fears of counterparty exposure to losses on mortgage-backed securities, as the cause of the credit squeeze. The Fed's actions, both on its own and in conjunction with the US Treasury, did nothing to allay those fears.

On the contrary: they compounded them by throwing good money after bad, rewarding imprudent financial firms at the expense of their more prudent rivals, including prospective buyers, while unsettling financial markets all the more by suggesting that even Bernanke himself was tossing in the towel on old-fashioned monetary policy.

Starting in the late summer of 2008, the Fed erred the other way. Thanks partly to its (and the Treasury's) previous missteps, including scare tactics used to cow Congress into approving the Treasury's bailout plan, a genuine liquidity crisis had taken hold by then. Yet the Fed resisted a much-needed loosening of monetary policy until early October. Then, although it finally took steps to aggressively expand bank reserve credits, it undermined the potential stimulus effect of doing so by starting a new policy of paying interest on bank reserves. In short, the Fed behaved much as it had back in 1936-37 when, fearing inflation (of all things), it decided to double bank reserve requirements, plunging the US back into the Great Depression from which it was struggling to emerge.

In many ways, Bernanke was dealt a tough hand when he became chairman. The Fed made lots of mistakes earlier this decade – primarily, holding interest rates too low for too long – that weren't entirely his fault.

... ... ...

If Congress really wants to encourage Bernanke to successfully combat future recessions, it needs to take steps to force him to stick to traditional monetary policy procedures, instead of congratulating him for innovations that may well have done more harm than good. After all, no one congratulates Granny, and she never did anyone any harm.

This article was published in the Christian Science Monitor on Thursday, September 17, 2009. Please read the original article here.
Author : George Selgin is a professor of economics at the University of Georgias Terry College of Business and a senior fellow at the Cato Institute in Washington.
Tags- Find more articles on - Federal Reserve | financial crisis | fiscan stimulus | monetary policy

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