David Blanchflower: Ben Bernanke's history lesson: doing too little is worse than too much

Economic Outlook: Policy inaction in 1928 and 1929 and premature tightening were major errors

A week ago the chairman of the Federal Reserve, Ben Bernanke, took the unprecedented step of teaching a class of lucky undergraduates at George Washington University. There are four lectures in total over the following 10 days. What a coup! I am so jealous that I couldn't persuade him instead to come and teach in my Financial Crisis of the Noughties class at Dartmouth College. His lectures provide important insights into his thinking on what went wrong in the Great Depression and why the Fed he leads did not repeat those mistakes this time around.

I am a huge fan of Ben Bernanke, who I think likely saved the world by his actions cutting interest rates, moving quickly to QE and saving the banks in 2007 through 2009. He has argued that without such actions it is conceivable that US unemployment would have reached 25 per cent rather than 10 per cent. That looks right. He comprehended the scale of the crisis well ahead of the Bank of England Governor, Mervyn King, who dithered over Northern Rock and argued for my first year or so on the Monetary Policy Committee that what happened in the US was irrelevant because the UK and the US had decoupled, which of course they hadn't.

This lecture series is part of Mr Bernanke's attempt to improve transparency and minimise uncertainty about what the Fed's actions will be when, eventually, it is time to withdraw stimulus. His first lecture was about what a central bank is and what it does, its mission and the Fed's failures in the 1930s, and was fascinating and worth watching online. The slides are also worth downloading from federalreserve.gov.

Mr Bernanke of course is the world's foremost economic scholar of the Great Depression, so he knows what he is talking about. The first lecture in many ways was also directed at the Republican presidential candidate, Representative Ron Paul, who astonishingly has argued both for the abolition of the Fed and a return to the gold standard. Mr Paul is also the chairman of the House Subcommittee on Domestic Monetary Policy and Technology which monitors the Fed. Mr Bernanke's regular appearances in front of the committee are a must watch, given that he doesn't suffer fools gladly.

Mr Bernanke explained in the lecture that the Fed emerged because the US needed a lender of last resort with sufficient resources to stop runs on illiquid, but still solvent, banks. Financial panics had occurred in 1873, 1884, 1890, 1893, 1907, 1914 and of course 1929. Stock market prices continued to fall from 1929 through 1932 and bank failures continued through 1934. Mr Bernanke explained that the gold standard did not prevent financial panics, and even though it promoted price stability over the long run, in the medium term it sometimes caused periods of inflation and deflation. A gold standard is subject to speculative attack and collapse if people try to exchange paper money for gold, which is what happened in the UK in the financial panic of 1931. We had to leave the gold standard, which then allowed the economy to grow. Because the money supply is determined by the amount of gold, it cannot be adjusted to changing economic conditions and does not prevent financial panics. As in the case of the peripheral countries in the euro area, the fixed exchange rates that operated under the gold standard meant that the effects of bad policies in one country were transmitted to other countries. Abandoning the gold standard ended deflation.

The chairman argued that the Great Depression occurred because of the economic repercussions of the First World War, including the effects of reparations payments, a bubble in stock prices and a financial panic, along with the collapse of major financial institutions. Monetary policy failures, in his view, included tightening in 1928 and 1929 and again in 1931 and policy inaction in 1932 despite high unemployment and falling prices. The Fed at the time responded inadequately to bank runs and the contraction of bank lending, providing only minimal credit to banks. More than a third of the nation's banks failed and failures continued until deposit insurance, which guaranteed deposits, was established in 1934. Mr Bernanke's conclusion was that the Fed failed because "it did not use monetary policy to prevent deflation and the collapse in output and employment ... and did not adequately perform its function as lender of last resort, allowing many bank failures and a resulting contraction in credit".

A powerful lesson Mr Bernanke drew from the Thirties is that policy inaction in 1928 and 1929 and premature tightening were major errors, and it is clear that his activist policies recently are a result of his understanding of what happened in the Great Depression. As my friend Adam Posen has often argued, on the monetary front, too little action is much worse than too much. A major error of monetary policy makers is to assume they are powerless when they are not.

An important new paper by two highly distinguished economists, Brad DeLong and Larry Summers*, has challenged the absurd claim made by George Osborne in last week's Budget, that he had no room to loosen fiscal policy. They argue that when interest rates are at the zero nominal lower bound as the UK currently is, timely and temporary expansionary fiscal policy "can be highly efficacious as a stabilisation policy tool". The recent experience in a number of countries suggests that fiscal stimulus can be reversed as the economy recovers. Growth is more important than the deficit at the zero bound. A major error of fiscal policymakers is to assume they are powerless when they are not.

If professors DeLong and Summers are right, fiscal stimulus can ease rather than exacerbate the UK government's long-term budget constraint. This undercuts Mr Osborne's claims even further that he is powerless to act to boost growth. He isn't and he should – now before it's too late.

*Brad DeLong and Lawrence B Summers, "Fiscal Policy in a Depressed Economy", March 2012.

David Blanchflower is professor of economics at Dartmouth College, New Hampshire, and a former member of the Bank of England's Monetary Policy Committee

Start your day with The Independent, sign up for daily news emails
PROMOTED VIDEO
News
ebooksNow available in paperback
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Marketing Services Manager - (communications, testing, DM)

£32000 - £35000 per annum + benefits: Ashdown Group: Marketing Services Manage...

Guru Careers: Finance Account Manager

£Neg. (DOE) + Excellent Benefits: Guru Careers: A Finance Account Manager with...

Ashdown Group: Java Developer - Hertfordshire - £47,000 + bonus + benefits

£40000 - £470000 per annum + bonus: Ashdown Group: Java Developer / J2EE Devel...

Ashdown Group: Direct Marketing Manager - B2C, Financial Services - Slough

£45000 - £55000 per annum + Benefits: Ashdown Group: An exciting opportunity h...

Day In a Page

Jeb Bush vs Hillary Clinton: The power dynamics of the two first families

Jeb Bush vs Hillary Clinton

Karen Tumulty explores the power dynamics of the two first families
Stockholm is rivalling Silicon Valley with a hotbed of technology start-ups

Stockholm is rivalling Silicon Valley

The Swedish capital is home to two of the most popular video games in the world, as well as thousands of technology start-ups worth hundreds of millions of pounds – and it's all happened since 2009
Did Japanese workers really get their symbols mixed up and display Santa on a crucifix?

Crucified Santa: Urban myth refuses to die

The story goes that Japanese store workers created a life-size effigy of a smiling "Father Kurisumasu" attached to a facsimile of Our Lord's final instrument of torture
Jennifer Saunders and Kate Moss join David Walliams on set for TV adaptation of The Boy in the Dress

The Boy in the Dress: On set with the stars

Walliams' story about a boy who goes to school in a dress will be shown this Christmas
La Famille Bélier is being touted as this year's Amelie - so why are many in the deaf community outraged by it?

Deaf community outraged by La Famille Bélier

The new film tells the story of a deaf-mute farming family and is being touted as this year's Amelie
10 best high-end laptops

10 best high-end laptops

From lightweight and zippy devices to gaming beasts, we test the latest in top-spec portable computers
Michael Carberry: ‘After such a tough time, I’m not sure I will stay in the game’

Michael Carberry: ‘After such a tough time, I’m not sure I will stay in the game’

The batsman has grown disillusioned after England’s Ashes debacle and allegations linking him to the Pietersen affair
Susie Wolff: A driving force in battle for equality behind the wheel

Susie Wolff: A driving force in battle for equality behind the wheel

The Williams driver has had plenty of doubters, but hopes she will be judged by her ability in the cockpit
Adam Gemili interview: 'No abs Adam' plans to muscle in on Usain Bolt's turf

'No abs Adam' plans to muscle in on Usain Bolt's turf

After a year touched by tragedy, Adam Gemili wants to become the sixth Briton to run a sub-10sec 100m
Calls for a military mental health 'quality mark'

Homeless Veterans campaign

Expert calls for military mental health 'quality mark'
Racton Man: Analysis shows famous skeleton was a 6ft Bronze Age superman

Meet Racton Man

Analysis shows famous skeleton was a 6ft Bronze Age superman
Garden Bridge: St Paul’s adds to £175m project’s troubled waters

Garden Bridge

St Paul’s adds to £175m project’s troubled waters
Stuff your own Christmas mouse ornament: An evening class in taxidermy with a festive feel

Stuff your own Christmas mouse ornament

An evening class in taxidermy with a festive feel
Joint Enterprise: The legal doctrine which critics say has caused hundreds of miscarriages of justice

Joint Enterprise

The legal doctrine which critics say has caused hundreds of miscarriages of justice
Freud and Eros: Love, Lust and Longing at the Freud Museum: Objects of Desire

Freud and Eros

Love, Lust and Longing at the Freud Museum