No matter how badly everyone else fared, you could depend on Bernanke to bailout the banks, whatever the…
by Mark Thornton via Mises
Along with Douglas Diamond and Philip Dybvig, Ben Bernanke was awarded the Nobel Prize in Economics today. The three have written extensively on the need to bail out the banks in times when the economy is in corrective mode, generally after a long period of monetary injections. Bernanke was Chairman of the Federal Reserve when he pushed for the latest round of bank bailouts in 2007-2009.
Bernanke’s research concentrated on the Great Depression and argued that the banks needed to be bailed out in the 1930s in response to the collapse of the stock market and the severe correction in the US economy. Diamond and Dybvig have also written on the implications of bank failures on the US economy. All three have latched onto the idea that banks take in deposits which are redeemable short term, but they make loans that are longer term and are thus susceptible to bank runs.
Their work is highly suspect from the view of economic theory and is derived from the point of view of history and the social sciences. They neglect the overall situation they are trying to explain, the role of institutions, and the basics of government intervention. For example, Bernanke’s work does not explain why the “situation” occurred in the first place, what the government did from the outset, or how it could be prevented in the future, except for ever-increasing government and Fed intervention.
Their research amounts to little more than an excuse to bail out the banks. Therefore, if you are a member of the privileged financial elites, the Housing Bubble and the ensuing Financial Crisis was an unmixed blessing. You made big money all throughout the housing and stock market bubbles and then your banks received several bailouts and special privileges during the bust, including borrowing at zero interest rates on loans, capital infusions, Quantitative Easing 1 & 2, and interest payments on “excess reserves.”
Of course, most importantly, you had your man in charge of the Federal Reserve, the man who literally “wrote the book” and dissertation, on how the Fed must bailout the banks in times of economic trouble. No matter how badly everyone else fared, you could depend on Bernanke to bailout the banks, whatever the costs to others.
The Great Depression is a pivotal event in American history, and it is also crucial in terms of economic theory and policy. Bernanke’s writings are pivotal in terms of redirecting government bailout policy from monetary policy to bank bailouts.
Milton Friedman’s monumental work argued that the Fed allowed the money supply to collapse in the early 1930s because it didn’t do enough to inject money into the economy. Instead, Joseph Salerno has /shown/ that the Fed was aggressive in trying to keep the money supply growing, but they failed. Bernanke’s work shows that banks failed in large numbers in the early 1930s and due to the negative expectations of banks (and the demise of many of them) were not an effective conduit of the Fed’s desire to pump up the money supply. Banks thereby became “systemically important.”
Each major school of economic thought has its own story of the Great Depression with Friedman and Bernanke representing the Monetarists, with Bernanke providing the “shock” that provided the “pluck” to Friedman’s Fed-piloted model, as explained by Professor Garrison.
The Keynesians of course have Keynes’s (1936) General Theory. He felt that the depression was caused by a failure of aggregate demand: people were unwilling to spend and invest causing the economy to contract via a psychological pathway, without any fundamental cause, thus necessitating government intervention to prop up the economy. This is the same “explanation” you would hear from your grocer, barber, or gas station clerk. Peter Temin filled out this historical narrative in his, / Did Monetary Forces Cause the Great Depression? / (1976) where he suggests that the cause was a decrease in the demand for money.
The debate between Monetarists and Keynesians devolved into bickering over aggregate supply and demand, model specifications, empirical results, and, at base, cause and effect.
The Austrian school has its own macroeconomic approach, and this can be seen vividly in the case of Great Depression. Ludwig von Mises wrote about the coming of the depression before it happened and what was causing it. In his day, Irving Fisher was the leading economist in the US and Mises showed that it was Fisher’s notion of a stable dollar, managed by the Fed, that was the cause of the depression. I explain this episode as evidence of the superiority of the Austrian Business Cycle Theory (ABCT). Lionel Robbins (1932) wrote a contemporaneous account of the Great Depression based on the ABCT.
Murray Rothbard’s America’s Great Depression provides a comprehensive view of the economics, politics, and policy implications of the event from the Austrian view. First, Rothbard shows that the Fed’s policies in the 1920s, based on Fisher’s views, were the fundamental economic cause of the depression. It was the Fed that was inflating the money supply during the 1920s and it was the Fed that had recently taken on the newly created function of “lender of last resort” thereby encouraging bankers to take on more risk and making our fractional reserve banking system more unstable in the first place.
Second, political action by Hoover, Roosevelt and others caused the depression to be great, in their attempt to keep prices and wages high, with regulations, tariffs, propping up malinvested resources through the Reconstruction Finance Corporation, and moral suasion. Third, the policy action in the 1930s to keep spending high and to restructure the American economy with New Deal policies lengthen the time of recovery. BTW: Robert Higgs showed that WWII did not get us out of the Great Depression.
While Bernanke et al are dependable in terms of recommending and endorsing bailout policies, the Austrian school seeks a better, fuller understanding and questions the fundamental effectiveness of such bailouts. The cause of the Great Depression was the Fed’s inflationary monetary policy of the 1920s. The New Deal policies of Hoover and Roosevelt that expanded the role of government in the 1930s did not prevent or reduce the impact of the depression, they made it great!
To address the fundamental problem that Bernanke, Diamond and Dybvig have fixated on and which any banker can explain, requires not an extensive quilt of government regulation, controls, and bailouts, but merely a sound money regime of money and banking without a central bank.
Author:
Mark Thornton is a Senior Fellow at the Mises Institute and the book review editor of the Quarterly Journal of Austrian Economics. He has authored seven books and is a frequent guest on national radio shows.
