Category Archives: Bad Monetary Policy 2008

An Open Letter to Congressman Paul Ryan


Dear Congressman Paul Ryan,

In a recent speech you made the case for a more rules-based approach to monetary policy:

The Fed’s recent departures from rules-based monetary policy have increased economic uncertainty and endangered the central bank’s independence…  Congress should end the Fed’s dual mandate and task the central bank instead with the single goal of long-run price stability. The Fed should also explicitly publish and follow a monetary rule as its means to achieve this goal.

I agree that we need a more systematic approach to monetary policy.  The ad-hoc nature of the QEs adds uncertainty and makes the Fed a political lightning rod for criticism.  Ultimately, this reduces the effectiveness of monetary policy.  So, yes, we need a predictable, rules-based approach to monetary policy.  We also need, however, an approach that responds appropriately to supply shocks.  For example, we wouldn’t want the Fed to follow a rule that would call for a tightening of monetary policy just because a major computer virus shut down most computer systems and, as a result, caused prices to go up.  Instead, what we need is an approach to monetary policy that keeps the growth of total current dollar spending stable so that the booms and bust are minimized.   The good news is there is a way for monetary policy to do this in a systematic manner.  It is called nominal GDP level targeting.  This approach would narrow the Fed’s mandate to single measure and thus make it more accountable.  I ask you to please consider this idea.  

For further reading on nominal GDP level targeting I suggest you read this article, this article, and this article from the National Review.

All the best,

David Beckworth

An Open Letter to Congressman Paul Ryan (David Beckworth)
Tue, 17 May 2011 14:56:00 GMT


Bad monetary Policy: Round and round…

It is more and more plausible that poor monetary policy really drove the economy off a cliff in 2008.  This to a large degree the same story as the cause of Great Depression in the early 1930’s (See:  A Monetary History of United States 1867-1930, Friedman and Schwartz)

The financial crash played a role in reducing the creation of money by lending against reserves (created by the fed), and increasing demand for money (reducing the velocity or spending for each dollar in people’s hands). 

Now we have to rely on the fed to manage what still seems like variation in people’s willingness to hold dollars and the banks willingness to lend to avoid inflation or other mischief.   The fed needs a consistent, but sophisticated response to those things.


Krugman and Taylor keep “jabbing” at each other about investment and unemployment and the role of government. So I don´t mind showing again that the slump that began in mid 2008 (not end 2007) is a direct consequence of monetary policy mistakes. And not the so called “mistakes of 2002-04” that Taylor keeps harping on, but the big mistake, reminiscent of 1929 that the Fed made in 2008.

Krugman never tires of saying that the ZLB makes all the difference (and evokes the 1921 recession (here) to argue that “conservatives” are dead wrong to use it as an example of the benefits of government keeping its “distance”).

As usual I go about showing arguments through a set of pictures.

The first shows the already standard indicator that after mid 2008 the Fed allowed nominal spending, that had evolved along a stable growth path during the “Great Moderation”, to “fall off a cliff”, something that had last happened in 1938. alt

Why did this happen? As we´ll see, it wasn´t the housing bust and the financial crisis that ensued, but the fact that monetary policy tightened significantly (despite the low level of interest rates – 2% from April to October 2008). The following picture shows that up to mid 2008, money supply increased to offset the fall in velocity (rise in money demand). But after that point money supply growth and velocity fall together. alt

To me this is the most compelling explanation for the “debacle” that followed. As seen in the next picture, residential construction employment peaked in early 2006. alt

But total nonfarm employment kept rising only dropping after mid 2008. alt

Unemployment was only 5.3% in mid 2008, after which point it “skyrocketed”. alt

The same pattern is seen in private investment. First, residential investment peaks at the end of 2005. alt

But nonresidential investment keeps chugging along up until, you guessed, mid 2008. alt

House prices (case-Shiller National) is shown next. alt

Prices peaked in early 2006. By mid 2008 prices had already dropped by 15%. But the economy was still standing! Also note that house prices began rising in mid 1997 (that´s an interesting story on its own) and just kept on going during the “low rate” period.

What was the government (at all levels) doing? The following pictures show government purchases (consumption and investment) and government expenditures on transfers and subsidies. alt

Both had increased somewhat (1 and 1.5 percentage points, respectively) between end 2006 and mid 2008. After that point government purchases increases another 1 percentage point while “automatic stabilizers” increase transfers and subsidies by almost 3 percentage points of GDP.

So what made the recession acquire the moniker “Great”? Monetary Policy mistakes!

I wonder what Milton Friedman would say if he were around. Maybe this will help find out:

Between 1980 and 2005, as the world embraced free market policies, living standards rose sharply, while life expectancy, educational attainment, and democracy improved and absolute poverty declined. Is this a coincidence? A collection of essays edited by Balcerowicz and Fischer argues that indeed reliance on free market forces is key to economic growth. A book by Stiglitz and others disagrees. I review and compare the two arguments.

alt alt alt alt alt alt alt alt

Round and round…
João Marcus Marinho Nunes
Sun, 03 Apr 2011 16:37:33 GMT

A different view of the Great Recession – Scott Sumner Presentation

Among lay people and professionals, it seems like the Recession’s accepted cause is a dependent on your ideology.  Conservative blame it on collapse of housing due to giving mortgages to poor people by bleeding hearts.  Liberals blame greedy banks to some degree for the same thing.  Another view is that monetary policy was too tight.  You may not agree, but I think you can at least learn something from this well done presentation of that third view.

Scott Sumner presents his views on the Great Recession to the Warwick Economic Summit via this video:
For more on Scott’s views see here.

Scott Sumner Presentation (David Beckworth)
Mon, 07 Mar 2011 00:11:00 GMT