At a 2002 conference honoring Milton Friedman on his 90th birthday, then Federal Reserve Governor Ben Bernanke concluded his remarks with…
“Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
It is fascinating to see how you can connect the dots between Dr. Bernanke’s remarks during that conference and current Fed (QE/quantitative easing) policy.
1928-1929: In his conference remarks, Dr. Bernanke tells us that although the U.S. economy was emerging from a recession during 1928, still the Fed felt it was more important to control excessive financial speculation. By raising interest rates, they not only constrained “Wall Street” but also economic activity. As a result, we had a new recession that led to the 1929 crash and further economic slowdown.
1931: Compounding the problem, the British pound collapsed in 1931. Lacking flexibility because of a gold standard, US monetary authorities worried that the US dollar was threatened. All they felt they could do was raise interest rates. Their goal? US securities would provide a higher return to investors thereby creating more demand for the dollar. Agan though, they contributed to the economic slowdown.
1933: Output was down 30%, unemployment close to 25% and prices had declined by 10%. However, the Fed believed they could do nothing because interest rates were close to 0%. By contrast, Dr. Bernanke says they were not really low at all when you look at real rates. Deflation meant the value of money was increasing and people would have to repay loans with dollars that were worth more.
Even bank failures generated minimal concern. Somewhat Darwinian, a positive opinion of bank failures meant only the strong would remain. But then, when stronger banks opened after FDR’s banking “holiday” during March 1933, they responded to the depressed economy with minimal lending.
Throughout his talk, Dr. Bernanke also commented on Fed leadership. At the helm of the Fed during the 1920s, Benjamin Strong was an able leader who, as the Governor of the Federal Reserve Bank of New York acted as de facto Chair of the entire system. But after he died in 1928, people with less ability took over.
With inadequate monetary policy and a power vacuum exacerbating the Great Depression, we can see why Chairman Bernanke initiated QE1, QE2, and QE3.
Here is a perfect 7 minute explanation of quantitative easing:
Sources and resources: Before looking further at Dr. Bernanke’s conclusions about the Great Depression here and here, I suggest looking at this (above) Whiteboard video. Marketplace’s Paddy Hirsch for a wonderfully clear explanation of quantitative easing.