Bernanke: Fed Must Avoid Greenspan Errors

by: Barry Ritholtz January 17, 2008    
Barry Ritholtz

Barry Ritholtz

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Well, it's a start:

Federal Reserve Chairman Ben S. Bernanke may encourage lawmakers today to stimulate the economy while aiming to avoid his predecessor's "regret'' of being tied to specific measures.

Legislators will question the Fed chief on steps to avoid the first recession since 2001 when he testifies to the House Budget Committee in Washington. Bernanke told members of Congress this week that some kind of fiscal stimulus is needed, according to Democratic lawmakers.

Former Chairman Alan Greenspan "misjudged'' the environment in which he endorsed tax cuts in 2001, and had "intense'' regret the eventual legislation excluded his specific guidance, he wrote in his 2007 book. Bernanke will try to avoid backing any particular tax or spending policies because doing so could earn criticism from legislators who oppose them, putting the Fed's reputation for independence at risk, analysts said.

Now if we can get the Fed to avoid the Greenspan policy of inflating our way out of every situation to the detriment of those who suffer from inflation, we will be making some progress.

Note that the major coverage of these Fed Chair comments misses the subtext of what Bernanke was implying (though Bloomberg came the closest): "Greenspan f&^%ed up! He compromised the Fed's independence for partisan reasons, and damaged the Fed's reputation. I won't make that mistake."

In this coming Sunday's NYT Magazine is a long piece by Roger Lowenstein titled The Education of Ben Bernanke, and I suspect it will be required reading. (I already picked out a cigar and some scotch for that very purpose).

I already spied this wonderful quote from former Fed Chair Paul Volcker: :

“I think Bernanke is in a very difficult situation,” Paul Volcker told me. Volcker was the Fed chief who preceded Greenspan and who conquered, painfully, the great inflation of the 1970s and early ’80s (he was chairman from 1979 to 1987). “Too many bubbles have been going on for too long,” Volcker added. “The Fed is not really in control of the situation."

Note that when it comes to enjoying low inflation rates, Volcker is the man who was most responsible. He should get credit. Truth be told, both the 80's Ronald Reagan boom and the 90's Bill Clinton boom were benefactors of Volcker's Fed. He broke rampant inflation, and the next 20 years of falling interest rates were the direct result of his policies.

When you compare the situation Greenspan inherited with the one Bernanke got stuck with...

Sources:
The Education of Ben Bernanke
ROGER LOWENSTEIN
NYT, January 20, 2008
http://www.nytimes.com/2008/01/20/magazine/20Ben-Bernanke-t.html

Bernanke Aims to Avoid Greenspan's Stimulus `Regret'
Scott Lanman
Bloomberg, Jan. 17 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=axNV4KGulqxI&

Bernanke Likely to Support Stimulus Effort
SARAH LUECK and SUDEEP REDDY
WSJ, January 17, 2008; Page A2
http://online.wsj.com/article/SB120051473033395285.html

Bernanke Is Said to Support Stimulus Measures
By EDMUND L. ANDREWS and DAVID M. HERSZENHORN
NYT, January 17, 2008
http://www.nytimes.com/2008/01/17/business/17fiscal.html

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This article has 11 comments:

  •  
    Jan 17 03:32 PM
    Volcker broke the back of inflation & then laid the basis for the next couple of decades of economic expansion?

    That's the decadence of economic theory. Through the years, Volcker's exegesis, debate, and reinterpretation consumed reams of paper and buckets of printer’s ink.

    Monetarism involves controlling the volume of total reserves, not the volume of non-borrowed reserves as administered by Paul Volcker. Monetarism has never been tried. If the money supply is controlled properly, the determination of interest rates can be left to market forces.

    In 1980, Paul Volcker, Past chairman of the Board of Governors of the Federal Reserve System, appeared before the House Domestic Monetary Policy Subcommittee. In response to a question as to why the Fed had supplied an excessive volume of legal reserves to the member banks in the third quarter 1980 (annual rate of increase 13.2%), Volcker's defense was that there are two types of legal reserves: 1) borrowed (reserves obtained by the banks through the Federal Reserve Bank discount windows), and 2) non-borrowed (reserves supplied the banking system consequent to open market purchases).

    He advised the congressmen to watch the non-borrowed reserves -- "Watch what we do on our own initiative." The Chairman further added --- "Relatively large borrowing (by the banks from the Fed) exerts a lot of restraint."

    This is of course, economic nonsense. One dollar of borrowed reserves provides the same legal-economic base for the expansion of money as one dollar of non-borrowed reserves. The fact that advances had to be repaid in 15 days was immaterial. A new advance can be obtained, or the borrowing bank replaced by other borrowing banks. The importance of controlling borrowed reserves was indicated by the fact that at times nearly 10% of all legal reserves were borrowed.

    The next 20 years also benefited from the decline in the proliferation of new financial instruments & the resulting drop in the rise in the transactions velocity of money.

    The sharp increase in DD velocity between 1964 & 1982 was the consequence of a variety of factors which include 1) the daily compounding of interest on savings accounts in commercial banks and “thrift” institutions, 2) the increasing use of electronics to transfer funds, 3) the introduction of negotiable commercial bank certificates of deposits, and 4) the rapid growth of ATS (automatic transfers of savings to DDs) and NOW (negotiable orders of withdrawal) accounts.

    But the most important single factor contributing to the increased rate of money turnover probably was those structural changes which made virtually all time deposits the equivalent of low velocity demand deposits

    Now our history books have been re-written.
    Reply | Link to Comment
  •  
    Jan 18 08:01 AM
    Barry is always a week or so behind !
    Reply | Link to Comment
  •  
    Jan 18 11:21 AM
    So flow5 your point is what? Are you suggesting the Fed doesn't really affect money supply or the subsequent inflation rate..or that it's policies, because not virginal monetarist, are therefore inconsequential? This is an investment site...not a forum for abstruse arguments about what a jack off Volker was..have any investment consequences you'd like to share or was this just a chance to blow off on a topic no one wants to listen to you talk about at home?
    Reply | Link to Comment
  •  
    Jan 18 12:27 PM
    I just love the media. What a bunch of dopes. The stimulus package is too funny, too. The govt. is going to give back some of the money they already took from us in taxes. Well, gee, thanks. The IRS never should have taken so much money in the first place. Remember, the more tax money the govt. takes, the more they spend on socialist policies.
    Reply | Link to Comment
  •  
    Jan 19 09:08 AM
    Georealist: Exactly, no one wants to listen at home or otherwise. But I didn't bring it up.

    There isn't a link to the money supply. Reserves are no longer "binding/restrict... And the money supply is unknown & unknowable.

    You invest? Are you making any money? Dec 07's projections:

    1/1/2006 0.59 0.31
    2/1/2006 0.22 0.11
    3/1/2006 -0.14 -0.03
    4/1/2006 -0.19 -0.07
    5/1/2006 -0.22 -0.07
    6/1/2006 -0.30 -0.02
    7/1/2006 -0.13 -0.02
    8/1/2006 -0.43 -0.18
    9/1/2006 -0.40 -0.06
    10/1/2006 -0.85 -0.18
    11/1/2006 -0.29 -0.17
    12/1/2006 0.12 -0.08
    1/1/2007 0.34 0.00
    2/1/2007 -0.14 -0.11
    3/1/2007 -0.36 -0.17
    4/1/2007 -0.27 -0.09
    5/1/2007 -0.12 -0.15
    6/1/2007 -0.04 -0.07
    7/1/2007 0.16 -0.08
    8/1/2007 0.15 -0.13
    9/1/2007 -0.19 -0.09
    10/1/2007 -0.48 -0.22
    11/1/2007 0.14 -0.18
    12/1/2007 0.44 -0.23
    1/1/2008 0.80 0.15 gdp falls
    2/1/2008 0.25 0.01 gdp falls
    3/1/2008 0.01 0.02 gdp falls
    4/1/2008 0.00 0.01 gdp falls
    5/1/2008 0.00 0.00 interest rates bottom
    6/1/2008 0.10 0.01 rebound
    7/1/2008 0.13 0.01 rebound
    8/1/2008 0.06 0.01 rebound
    9/1/2008 -0.20 0.04 U.S. dollar drops
    10/1/2008 -0.51 0.06 U.S. dollar drops
    11/1/2008 0.20 0.05 U.S. dollar drops
    12/1/2008 0.35 0.02 U.S. dollar drops

    Interest rates bottom in May/June (other things being equal). If the proxy for real-gdp drops from 80 to 1, in 2 months, then the U.S. will experience negative real growth rates.
    Reply | Link to Comment
  •  
    Jan 19 09:15 AM
    This is the GOSPEL Georealist:

    Banks as a system don’t loan out anything. They create money when they make loans.

    Money creation is not self-regulating

    You can’t take money out of the banking system (only the FED can)

    Savings transferred through the intermediaries never leave the CB system. The intermediaries are the customers of the CBs.

    Savings held in the commercial banking system are lost to investment or to any type of expenditure.

    From the standpoint of the economy the banks shouldn’t pay for something they already have. Payments on savings raise all interest rates, induce disintermediation among the financial intermediaries, shrink real-gdp, & lower CB profits.

    The solution to our current problem is to get the money creating depository institutions out of the savings business.
    Reply | Link to Comment
  •  
    Jan 19 10:24 AM
    The largest percentage of currency crisis which purportedly (by Poole) weren't foreseen - were exclusively the Federal Reserve Board's fault.

    If the world's largest economy ($13b+) has a contraction in its economy, imports will fall, & export driven countries will suffer, exacerbating the negative flow of funds, and any currency crisis.

    Mexico crisis 2/17/1982 (not identified) - Peso was pegged
    Listed below, currency crisis that were predictable & preventable (MVt):

    (1) Black Monday Oct 19 1987 (same day)
    (2) Mexico Peso crisis Dec 1994 (2 months early) Peso was pegged
    (3) U.S. dollar fall in Mar. 1995 (same month)
    (4) Asian financial crisis July 1997 (one month late) - without primary time series
    (5) Russian financial crisis 1998 (same month) - without primary time series
    Reply | Link to Comment
  •  
    Jan 19 10:25 AM
    Yea for these, our sterling pieces, all of pure Athenian mold -- ARISTOPHANES, THE FROGS

    Monetary flows (MVt) peaked Oct. 1974 (the stock market bottom)
    Monetary flows (MVt) peaked Oct. 1982 (1 month after the stock market bottom).
    (MVt)'s lag for long-term rates peaked Sept. 1981 (this century's peak in long-term interest rates).
    Monetary flows (MVt) peaked in Jun 1984 (the stock market bottom) 1 option trade beat Prechter's trading championship record with his 200+ trades
    Lags are not coterminous, e.g., the stock market bottom of 1982 was identifiable a year and ½, earlier
    Reply | Link to Comment
  •  
    Jan 19 10:27 AM
    Go, presently inquire, and so will I, where money is. --- THE MERCHANT OF Venice

    1938-1940 roc's in free legal reserves pulled us out of the depression.
    1951 (Korean War) had the highest roc’s in inflation & in free legal reserves since WWII.
    1973 had the highest roc's in inflation & the highest roc's of free legal reserves ever.
    1979-1980 had the highest rates of inflation & the highest roc's of free legal reserves ever.
    “Black Monday" Oct. 19, 1987, coincided with the sharpest and fastest peak-to-trough decline in the roc for real GDP since 1915.
    The stock market's 1QTR top in 2000 coincided with a +3.24 (roc) in Dec. 1999, which reversed to -.32 in Feb 2000. An historic reversal.
    Feb 27 coincided with the sharpest decline in 1) the absolute level of free legal reserves, & 2) & an historically large peak-to-trough reversal of roc’s for proxies on real GDP & the deflator.

    The policy rule is ex-post (e.g, Taylor Rule).

    Bank debits & free legal reserves are ex-ante.
    Some people think Feb 27, 2007 started across the ocean
    Reply | Link to Comment
  •  
    Jan 19 10:36 AM
    There's nothing esoteric about correcting errors.
    Reply | Link to Comment
  •  
    Jan 19 01:50 PM
    Man --- Flow5 sure started flowing !!!
    Reply | Link to Comment
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