Challenge facing the ‘academic’
By Samuel Brittan
Published: September 13 2007 17:31 | Last updated: September 13 2007 17:31
One of the more ridiculous charges against Ben Bernanke, chairman of the Federal Reserve, aired on the lower reaches of Wall Street is that he was an academic and that now was not the time for an academic. This only shows how some of the foot soldiers in the marketplace are the worst advocates of capitalism.
I would propose a deceptively simple test for any actual or proposed intervention by the central banks to shore up financial institutions. This is: could you justify the measures to a blue-collar worker who has been made redundant in a British car factory or an American cotton mill and who has spent some of his enforced leisure mastering the principles of economics?
It so happens that Mr Bernanke’s academic work is highly relevant. It has nearly all been on the Great Depression of the 1930s, whose scars still remain on American life and thought. When he first joined the Fed in 2002, Mr Bernanke had to lay aside 120 pages of a book he was writing on that depression. This must have been forced on him by a middle-level security-obsessed bureaucrat. Surely the Fed ought to have the benefit of its chairman’s research, especially when dealing with credit crunches such as the present one? He himself ought to have the opportunity of revising his text in the light of recent developments.
Fortunately, before he became entangled in these restrictions he did edit and help write a book, Essays on the Great Depression*. The volume does not claim to be the complete story. Mr Bernanke’s motive was that understanding the depression would provide important clues to what can go wrong with capitalist market systems.
Like Milton Friedman, Mr Bernanke stresses the monetary roots of the depression. There is another wrinkle that Mr Bernanke introduces. This is that a weakening of financial institutions can aggravate a slump quite directly, apart from the effects on the money supply. Neither he nor Friedman has attempted a complete explanation of the weakening of economic activity that preceded it. Their interest has been in the forces that turned what might have been a normal recession into the greatest economic disaster of the 20th century.
But Mr Bernanke adds quite a lot to the original Friedman analysis, mainly through international comparisons. The depression was a world phenomenon. But its depth, time of onset and speed of recovery varied from one country to another and the differences were strongly correlated with the behaviour of the money supply in each of the countries. Bernanke also emphasises the role of the international gold standard in the spread of depression. Those countries that abandoned the gold standard recovered more quickly than countries that clung on to unsuitable gold parities.
Given these background studies it is quite ludicrous to suppose that Mr Bernanke is impervious to the dangers of US and world recession. Obviously he has to convince other members of the Fed Open Market Committee; and he has to convince himself that he is not adding to moral hazard by injecting “cheap money and plenty of it” when inflation may still be lurking around the corner. An approach like that of the Charge of the Light Brigade might impress Nicolas Sarkozy, the new French president, but few serious economic actors. The principle of what needs to be done is pretty well known and was proclaimed by the English writer Walter Bagehot a century and a half ago. This is that the central bank must be willing to lend to responsible market participants unlimited sums but at a penalty rate, and avoid bailing out individual financial institutions from their own mistakes.
But what should central banks do about their policy rates, such as the Bank Rate in the UK and the official Fed Funds rate in the US, which determine normal lending to the financial markets? Would it be an inflationary bail-out to reduce some of these official rates not long after central bank heads have been giving warning of likely future increases in them? The answer here must surely depend on the general economic outlook. If the Fed or the European Central Bank were to reduce its official rates because it saw recession on the horizon, this would not be a bail-out for institutions that had indulged in excessive risk, but a general stimulus all round. It would be quite consistent with charging distressed borrowers a penalty rate. For even if they had to pay less than they do now it would still be at above prevailing market rates.
There is another unresolved problem. According to the Goldman Sachs European Weekly Analyst, the ECB remains convinced that general monetary policy and liquidity management are two distinctly different jobs. I hope that Mr Bernanke’s studies of the Great Depression have convinced him otherwise.
The Goldman Sachs economists do indeed discuss some of the channels from the financial side to the real economy. But they still seem to me to minimise them. “In what we presently see as an extreme case,” they say, “our 2.3 per cent growth forecast for the euro area for 2008 could be cut to 1.6 per cent.” We should be so lucky.
*Princeton, 2000
Copyright The Financial Times Limited 2007
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