Saturday, July 25, 2009

The Tight Money Summer of 2008 and Its Meaning for the Future

My contention has long been that the financial crisis intensified in September 2008 because that summer money supply growth was brought to a near halt by the Federal Reserve.

Bob Murphy emails to say: academic paper saying fed was too tight in spring of 2008.
I'm glad someone is catching up with EPJ.

In a paper by Robert Hertzel, Monetary Policy in the 2008-2009 Recession, writes:

The recession that began with a cyclical peak in December 2007 originated in a combination of real shocks because of a fall in housing wealth and a fall in real income from an increase in energy prices. The most common explanation for the intensification of the recession that began in the late summer of 2008 is the propagation of these shocks through dysfunction in credit markets. The alternative explanation offered in this article emphasizes propagation through contractionary monetary policy. The first explanation stresses the importance of credit-market interventions (credit policy). The second emphasizes the importance of money creation (money-creation policy).
This Hetzel quote comes via Scott Sumner, who writes of the paper:

Hetzel’s paper contains so many nuggets of wisdom that I will return to it again and again in the next few weeks. It is one of finest monetary narratives that I have ever read, and certainly far and away the best published narrative of this crisis. In fact nothing else even comes close. Just to whet your appetite, he presents a wealth of evidence that Fed policy became effectively more contractionary over the summer of 2008. Some of this I was unaware of, but you can be sure I will have more to say in future posts.
With all due respect to Sumner (He seems to be a genuine seeker of truth), what the hell was he watching last summer? In bizarre fashion, economists have given up watching money supply. And Hetzel's paper may be a fine work, but you could have gotten a real time advisory of what was going on with slowing money supply by simply reading EPJ. We nailed the story as it was happening, see here, here, here, here, here, here, here and here.

As for the relevance of all this to today, Bernanke is back to slow money growth, indeed right now he is shrinking money supply. If Bernanke doesn't reverse engines real soon, we are going to get smashed big time with a brutal second dip to the recession.

1 comment:

  1. I would emphasize the word "published" in the quotation you take from my blog. I have been complaining about tight Fed policy in any forum I can for nearly a year. Basically working full time on the problem. But although I haven't been able to publish the sort of article Wetzel did, my blog is far longer that "War and Peace" by now, and is full of many similar points. I'm glad to hear that you saw this problem even before I did. Keep up the good work.