The Great Recession of 2007-08

The title of Bernanke’s memoirs states the theme of this document that focuses on his term as chairman of the Board of Governors of the Federal Reserve System. And the term document is appropriate because it is a very detailed account of the 2007-08 financial crisis and the Great Recession that followed. Though there have been numerous accounts of these events, this book is and will likely remain the best, most authoritative work on how the Fed and other government agencies addressed the crisis, devised often innovative remedies and kept the economy from spiraling even further downward into another Great Depression.

Bernanke’s story starts well before he became Fed chairman in January 2006, and it is not just filler. His academic background and studies made him the right man in the right place when the financial crisis hit. He was a disciple of Milton Friedman, the leader of the Chicago School of monetary thought who won the Nobel Prize in 1976. But it was less economic theory than Friedman’s analysis of the Great Depression contained in his mammoth Monetary History of the United States (written with Anna Schwartz), which Bernanke read while working on his PhD at MIT. Bernanke writes that after reading this book, he “had become a Great Depression buff in the way other people become Civil War buffs.” The conservative Friedman-Schwartz view replaced that of the liberal John Kenneth Galbraith view that the depression stemmed from the 1929 stock market crash and “speculation.” As Bernanke argues:

Friedman and Schwartz showed that the collapse of the money supply in the early 1930s, rather than the Great Crash, was the more important cause of the Depression. The sharp decline in the money supply hurt the economy primarily by inducing a severe deflation (falling wages and prices)….This violent deflation in turn led households and firms to postpone purchases and capital investments….depressing demand and output.

The money supply collapsed because the banks collapsed. Nearly 40 percent of all the nation’s banks closed between 1929 and 1933. The modern capitalist economy has become even more dependent on finance as its life blood, and while the banks are still central to the system, a host of other financial entities have evolved. They are the pillars of the economy, and if they crumble so will everything else. The Friedman-Schwartz lesson was that not enough was done to keep the system up and running in the 1930s; it was allowed to fail, imposing frightening costs on society. Bernanke was determined to act with vigor to prevent another collapse and extended Fed authority to the limit to salvage more than just the banks.

Bernanke’s fortuitous choice as Fed chair did not come out of the blue. He earned his bachelor’s degree in economics from Harvard and then his PhD from MIT in 1979, when the country was experiencing both high inflation and mass unemployment (stagflation), so he was quite aware of the Fed’s role in both regards. He was a professor of economics at Stanford University from 1979 until 1985, when he moved to Princeton. He wrote a number of important papers on monetary policy and became increasingly involved in the Federal Reserve System. He served as a visiting scholar and academic advisor to several regional Reserve Banks, further honing his ideas. He become a Federal Reserve Governor in 2002, recommended for President George W. Bush’s appointment by Glenn Hubbard, a noted free market economist serving as chairman of the Council of Economic Advisors in the White House.

Bernanke’s pedigree is important given that a number of supposedly conservative critics have objected to his activist leadership at the Fed, forgetting that his policies were based on the legacy of capitalist guru Milton Friedman and supported by a Republican administration (which was followed by the Democratic Obama administration because voters in 2008 did not think enough was being done). The book reveals, in diplomatic language, how blind so many GOP lawmakers can be towards saving the capitalist system they supposedly glorify on the stump. Letting things fall apart is the antithesis of any proper notion of conservatism.

Nothing has damaged the party more, including losing the 2012 president election, as the public perception that Republicans don’t care about the national economy or the creation/protection of jobs. They are blamed for being in the pocket of Wall Street, without appearing to understand the links between finance and the real economy. They are damned from two directions, and seem hapless on both fronts. Consider one example Bernanke mentions; a bill sponsored by Sen. Bob Corker (R-TN) and then Rep. Mike Pence (R-IN), now the Governor of Indiana, to remove the Fed mandate to support full employment! A political suicide note if there ever was one.

During one of this year’s Republican Presidential debates Sen. Ted Cruz (R-TX) proudly announced he was co-sponsoring Sen. Rand Paul’s (R-KY) bill to “audit the Fed.” Rand’s father, former Rep. Ron Paul (R-TX), has long been hostile to the Federal Reserve, which he painted as a creature of greedy bankers (a view now promoted by Socialist Sen. Bernie Sanders of Vermont). Populists complain that the Fed is not “democratic.” True, it is a professional institution of technocrats that was created to be independent of political pressure; which is why it has consistently performed better than other government institutions.

When this issue comes up, Bernanke tells his audience, “if they are impressed with Congress’s management of the federal budget, they should support audit-the-Fed legislation to give Congress the responsibility for making monetary policy as well.” One gathers, however, from Bernanke’s accounts of meetings with Congressional leaders of both parties that the politicians are quite happy to defer to the Fed and the Treasury for the taking of action, leaving them free to pose for the voters.

Critics on the right fear the Fed will create too much money and fuel inflation; but countless studies over time and across countries show that the more independent is the central bank, the less inflation is generated. Political pressure is always in the direction of spending more, which in normal times will push up prices.

The Great Recession was not, however, normal times. Fiscal stimulation was necessary in partnership with Fed monetary actions. Indeed, the budget deficits were so large that the Fed had to create money to help finance them as the private economy could not have carried such a debt burden. Since the 2007 crisis, the Fed has tripled the amount of the national debt it has “monetized” to over $2.4 trillion. While critics claimed such purchases of Treasury securities, especially during the period of “quantitative easing” would be inflationary, this has not occurred. Indeed, more people are now complaining about a lack of cost of living adjustments to their incomes because inflation has been so low that no upward adjustments are warranted.

The experts at the Fed have calculated well, keeping a tricky balance between supporting economic growth with a policy of financial accommodation, while watching the real economy carefully to avoid inflation. With a growth rate of only one percent during the last quarter of 2015 and a real unemployment rate of 8.9 percent, the U.S. economy is a long way from reaching its potential output. There is little chance of upward pressure on prices. The greater risk is that the economy may fall back into stagnation or even another recession.

One really has to marvel at how slow the economy has responded to the massive fiscal and money stimulus pumped into it. Bernanke notes that in the initial Obama stimulus package, the American Recovery and Reinvestment Act of 2009, only $105 billion out of the total $787 billion appropriated went for the much heralded “shovel ready” infrastructure programs. Most of the money went to help State and local governments pay their employees and cover Medicaid costs. There was little to increase output or productivity in the business community as had been the case with the Bush administration’s earlier rescue of the auto industry. Money cannot just be spent, it must fund the right things.

There is far too much detail in this book to cover in a review. Bernanke fills every page with facts and insights. Yet, the author’s style makes it an easier read than one would have thought; and well worth the effort. No one should comment further about the crisis and the policies devised to combat it without first digesting Bernanke’s account.

William R. Hawkins, a former economics professor and Congressional staffer, is a consultant specializing in international economics and national security issues. He is a contributor to SFPPR News & Analysis.