Matt O’Brien has a great piece in The Atlantic on what went wrong during 2008. Read the whole thing. Because of grading responsibilities, etc, I haven’t had time to read all the minutes. But the picture is pretty much what I would have expected. Here is his conclusion:
What was to be done?
None of this was inevitable. The Fed could have ignored oil prices that summer, and told us it was ignoring them. And it could have saved Lehman that fall. It wouldn’t have been easy—or popular—but it wouldn’t have been impossible, either. That’s clear if you look at what Rosengren was saying in real-time. With that in mind, here’s a look at what the Fed could have, and didn’t do, to make the Great Recession a little less so.
1. Oil shock. Graded on a curve, the Fed did okay. At least it didn’t raise rates that summer like the ECB did. But on an absolute scale, the Fed could have done better. It could have done in 2008 what it did in 2011, when another oil spike came along: say that the increase in inflation was transitory, and they were focused on long-term inflation expectations instead.
Now, more dovish language that summer wouldn’t have saved the world. But it would’ve kept money a little looser. And that could’ve given the financial system a little more breathing room to keep raising capital, like the Fed had been doing before.
2. Lehman. There are three magic words in central banking: whatever it takes. The Fed did that with Bear. It didn’t do that with Lehman. It could have let Lehman become a bank holding company, which is what Lehman wanted, and what the Fed ended up doing for Goldman Sachs and Morgan Stanley a few weeks later. Or it could have given Lehman bridge financing to try to finish a deal after everything fell through on September 14th. None of these would have been popular decisions, but what’s the point of an independent central bank if it won’t do unpopular things to save the economy?
After the fact, the Fed has said that it couldn’t do these things, that it had no choice. But the transcripts show that it was a choice, and they knew it. Some of them thought nothing bad would happen. And they were happy about it in September—well, all but Rosengren—until they realized what a world-historical error it was.
A few comments:
1. The flawed monetary regime (failure to level target NGDP) made these seemingly small tactical errors in mid-2008 much worse than they would otherwise have been.
2. I am pretty sure Matt is not a market monetarist, or at least he’s more Keynesian on issues like fiscal stimulus than I am. Thus it’s heartening to see the MM interpretation of 2008 become increasingly accepted by the mainstream press. When people like David Beckworth and I were starting out on this crusade, the notion that excessively tight money was the problem was almost laughed off the stage. ”Interest rates were 2%, how can you claim money was tight in 2008?” Now the MM narrative is becoming increasingly accepted in the media. That’s great news.
3. Elsewhere Matt praises Frederic Mishkin. He also directed me to a Hilsenrath piece that said Mishkin came off looking relatively bad in the transcripts. But Hilsenrath was focusing on Mishkin’s jocular style. If you look at content of his analysis he was ahead of most of his colleagues. (In terms of forecasting Rosengren seems to have been the best.) I did a post over at Econlog a few days ago praising Mishkin’s farewell comments, but forgot that he had been equally brilliant at the final meeting of 2007.
4. As you’d expect Marcus Nunes also has this period covered, in a thorough analysis. Every once and a while someone tries to argue that Japan actually hasn’t done that poorly over the past few decades. Marcus nicely shoots down that argument with this post.