Tuesday, August 28, 2007

Punch at Caesar's Funeral

Contrarian that I am, Daniel Gross’ latest Moneybox commentary in Slate (hat tip: Mark Thoma) has all but convinced me that a drastic easing of Fed policy will be necessary to avoid a major recession. The main thrust of his commentary seems to be that, because a lot of rich people and conservatives want the Fed to cut interest rates, therefore anyone who is not rich or conservative should regard such a cut as a bad idea. (He doesn’t make that logic explicit, but since the commentary contains little explicit logic, I feel entitled to read between the lines.) To me, as a non-conservative* who is not (yet) rich (certainly not in the same league as Mr. Gross’ “motley collection of gazillionaires”), the observation that such people are “begging the Fed to cut interest rates” tends to reflect well on them rather than reflecting badly on the possibility of interest rate cuts.

At the end of the commentary, Mr. Gross does attempt to make an actual argument against interest rate cuts, but I fear he has confused metaphor with reality:
College students don't alleviate the after-effects of an evening spent at the punch bowl by returning to lap up the dregs. Just so, finance types should know that cheap money, credit on demand, and endless leverage aren't the cure for a hangover caused by too much cheap money, leverage, and credit on demand.
Or perhaps he has merely forgotten some relevant history. Unlike me, Mr. Gross does have a degree in history, so perhaps he will be able to find historical examples to buttress his case. (There were none in this particular commentary.) But to my own sparsely tutored ear, his analogy bears an unpleasant resemblance to the type of argument that was often heard in policy circles during the period 1929-1932.

As a matter of macroeconomics, I would say that “cheap money, leverage, and credit on demand” are precisely the cure “for a hangover caused by too much cheap money, leverage, and credit on demand” – at least to the extent that said hangover carries a risk of recession or deflation. If only the Fed had provided cheap money and credit on demand in late 1929 and 1930 (or, for that matter, 1931 and 1932), history might have turned out quite differently (and, I dare say, better). Perhaps Mr. Gross can cite some recent history – the 1998 experience – as an example of what’s wrong with easing monetary policy in response to a mass deleveraging. I have to ask, though: If the choice is between risking another 1999 and risking another 1931, which one should we be more concerned about? I pause for reply....


Not that we really have to worry about a repeat of the 1930s. Ben Bernanke is an economic historian – and an expert on the Great Depression, at that. As soon as he gets a strong whiff of recession, he will do anything but repeat the mistakes of the early 1930s. But it’s also clear that Chairman Bernanke is bending over backward to avoid repeating 1998. The last three weeks have been a case study in how to loosen monetary policy without loosening monetary policy. And it’s worth noting that the US economy was a lot stronger going into 1998 than it was going into 2007.

The classic “punch bowl” metaphor adopted by Mr. Gross has (at least) one major limitation: unlike alcohol, money is pretty much essential to the functioning of a modern economy. Certainly the Fed should take away the ice cream before our waistlines start to inflate. But when our bulimic economy realizes it has eaten too much, there are healthier approaches than encouraging vomiting and fasting.


* I hesitate to use the word “conservative” in any substantive context, however. The fact that “conservatives” are calling for easy money is yet one more small contribution to the mounting evidence that such words have little left in the way of meaning.

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