Ben Bernanke’s Valedictory

He says,

The Federal Reserve responded forcefully to the liquidity pressures during the crisis in a manner consistent with the lessons that central banks had learned from financial panics over more than 150 years and summarized in the writings of the 19th century British journalist Walter Bagehot: Lend early and freely to solvent institutions

The Bagehot policy is to lend freely, at a penalty rate. If you lend freely at a penalty rate, you effect financial triage. Banks that are fine don’t borrow. Banks that are insolvent go under anyway. And banks that are temporarily illiquid use your loans to recover. Instead, if all you do is lend freely, then you are simply handing out favors, which turns banking into an exercise in favor-seeking.

He goes on to say,

Weak recoveries from financial crises reflect, in part, the process of deleveraging and balance sheet repair: Households pull back on spending to recoup lost wealth and reduce debt burdens, while financial institutions restrict credit to restore capital ratios and reduce the riskiness of their portfolios. In addition to these financial factors, the weakness of the recovery reflects the overbuilding of housing (and, to some extent, commercial real estate) prior to the crisis, together with tight mortgage credit; indeed, recent activity in these areas is especially tepid in comparison to the rapid gains in construction more typically seen in recoveries.

This is a popular story among Keynesians now. It was not in the textbooks before the crisis.

Scott Sumner will be disappointed to see that Bernanke does not believe in the theory of monetary offset.

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7 Responses to Ben Bernanke’s Valedictory

  1. Lord says:

    He undoubtedly sees allowing Bears to be sold off and Lehman to go bankrupt as enough. There is always the question of where to draw the line during a panic, but the problem is too big to fail. Did anyone expect him to change how America works? Textbooks neglect history to their own fault.

    • andrew' says:

      There is also the question of who draws the line. Ad hoc idiosyncratic bailouts are not continuous with Bagehot.

  2. andrew' says:

    Is monetary offset here using the money to pay down debt? That’s not all bad considering the fed’s rope a dope with interest rates 2001-2006. 2008 WAS the triage.

  3. Chairman Bernanke was never able to convince the committee to do what Prof. Bernanke preached. Hence, he failed to get the growth and inflation he wanted. Who is he going to blame–the hawks, or fiscal policy. By blaming fiscal policy, he lets his colleagues off the hook.

  4. Scott Sumner says:

    That was kind of an odd comment to make in a post that makes no mention of fiscal policy, inflation or NGDP. No one ever claimed that offset applied to RGDP. You are right that he says he doesn’t believe in monetary offset, but that’s not apparent from any of the quotes you provide. I wouldn’t say I’m “disappointed” to find out that Bernanke doesn’t agree with me. Given that I’ve been highly critical of Fed policy, it would be rather bizarre if he did agree.

    BTW, At a press conference I could frame a question in such a way that Bernanke would answer it claiming that he does believe in monetary offset. It would be easy to do.

    • Arnold Kling says:

      Scott, I was referring to other comments Bernanke made in his speech, not to the quoted paragraph. It was an offhand comment, not related to the post.

  5. Kurt says:

    If you were writing legislation to ensure that Fed lending is accompanied by “penalty rates,” how would you phrase it?

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