Why isn’t the Fed omniscient? Conservatives want to know!

The Federal Reserve caused the Great Depression. It also caused the Great Recession. Why? Because it couldn’t predict the future. That’s the late Milton Friedman’s explanation for the GD, and it’s now David Beckworth and Ramesh Ponnuru’s explanation for the GR,

“It took a bigger shock to the economy [than the decline in the housing market beginning in 2007] to bring the financial system down. That shock was tighter money. Through acts and omissions, the Fed kept interest rates and expected interest rates higher than appropriate, depressing the economy. This point is easy to miss because the Fed lowered interest rates between September 2007 and April 2008. But raising rates is not the only route to tighter money.

“Between late April and early October, the Fed kept the interest rate over which it has most direct control, the federal funds rate, at 2 percent. But when the economy weakens, the “natural” interest rate — the rate that keeps the economy on an even keel — falls. By staying in place, the Fed’s target interest rate was rising relative to that natural rate. The gap between expected interest rates and the natural rate was rising even more. Fed officials spent the late spring and summer of 2008 warning that rates would have to rise to combat inflation. Futures markets showed a sharp increase in expected interest rates.”

It’s always amusing to hear conservatives, who 99% of the time are bellowing warning about the dangers of inflation (like now, for example), attack the Fed for not inflating the economy enough. And someone more patient, and more knowledgeable, than I could point out a number of ways in which Dave and Ramesh “massage” the facts to make their case. But I will point out all by myself that, prior to the decline/collapse in housing prices, warnings regarding the danger of their collapse were dismissed on the grounds that, even if they did collapse, housing only represented 4% of the U.S. economy. The powers that were were ignorant of the trillions of dollars of short-term financial instruments created on Wall Street whose values could fall overnight if housing prices went into a significant decline.

One could also point out—and I will—that Ben Bernanke, head of the Fed at the time, was, well, a Republican,¹ who was urged by people like Larry Summers, who was, well, a Democrat, to cut rates in late 2007. I’ll also point out that Dave and Ramesh are (silently) abandoning the old “it’s all the government’s fault” Republican talking point that fingered Fannie Mae and Freddie Mac (and, of course, that old debbil Barney Frank) as the cause of the collapse.

Afterwords
I don’t buy into the Bernie Sanders/Lizzy Warren “evil bankers” theory. Studies I’ve read (and found persuasive) argue that the guys selling the Kool-Aid drank it too. They put their money where their mouth was and they would have lost everything if the government hadn’t bailed them out. What was seriously tacky was that after the government saved their asses, they turned around and blamed the government for what were in fact the fruits of their own ignorance and greed. Read me on this here or (quite a bit more knowledgeable) Mike Konczal here and here.