3/31/2008

Lessons from the Depression

The article, Lessons from the Depression, explores Fed Chief Ben Bernanke’s background as a student of the era and how he aims to not repeat mistakes made in the past. Bernanke concluded that the actions taken by the Fed’s to increase interest rates during the depression actually lengthen it. So as a response to our current financial crisis, he has charted a course of lower interest rates despite concerns of inflation and the weakening dollar.

If the supply of money is held constant, a reduction in interest rates should increase the demand for money –causing a rightward shift of the demand curve. This shift in demand should drive prices higher, or in other words, should encourage inflation (all other factors held constant). Is this the price we have to pay to dampen the blow of an all out recession?

4 comments:

Rearden said...

No sooner after I had I placed this post, I came across this article http://www.msnbc.msn.com/id/23880336/
announcing a proposal to overhaul the entire US financial regulatory system. Is it just me, but aren't the actions of the Fed more alarming then the speeches they give concerning the state of the economy?

Olivia said...

The guts of the proposed changes are really interesting and I think that there is danger in increasing the regulatory responsibility of the Fed. Milton Friedman makes it clear in “Free to Chose” that the great depression was only magnified by efforts of the loosely organized Reserve System. Here is a link to the Cato Institute’s insights about the new proposal.
http://cato.org/view_ddispatch.php?viewdate=20080331#1

Lily said...

My main problem is people in this country do not know how to save money. Credit card debt keeps getting higher and mortgages are foreclosing. Yet the FED encourages spending with lower rates. Inflation compounds the problem increasing the demand for spending because people can by more today with a dollar than they can tomorrow.

Dr. Tufte said...

-1 on Rearden for poor editing.

I agree with Bernanke's analysis: monetarists have spent the last 40 years arguing that the depression was made worse by contractionary monetary policy.

I also think it is a lot harder to figure out what is actually expansionary and contractionary. The evidence from Japan in the 90s is that these things are moving targets: you need to err on the side of being too aggressive.

I worry about the move towards more regulation of financial markets. How exactly did the regulators help prior to mid-March? I'm just not sure it follows that just because they were ignorant before that getting more control can solve that problem. Rather, why don't they try to be less ignorant? It seems to me they could learn a whole lot more about how the derivatives markets work before sticking their hands in and making a mess.