Friday, April 13, 2012

The Third M: Money

I'm not above indulging in a bit of schadenfreude, so I have to admit that for me one of the silver linings of the economic crisis has been Alan Greenspan's remarkable fall from grace. As the boom of the late 1990s reached ever giddier heights (remember all that talk of Dow 36,000?), the former Federal Reserve chairman was feted by pundits and politicians across the political spectrum as the maestro of the market, who guided the economy with the confident self-assurance of a symphony conductor.

Fast-forward to October 2008, with the economy in shambles and the go-go days of Clintontime a distant memory. As stock market values plunged ever lower, foreclosures exploded, and millions of Americans found themselves thrown suddenly out of work, Greenspan appeared before the House Committee on Oversight and Government Reform to answer for the chaos. The committee chair, Rep. Henry Waxman (D-CA), was blunt in his questioning: “You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others...Do you feel that your ideology pushed you to make decisions that you wish you had not made?” Greenspan's reply: “Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”

According to a wide range of economists and politicians, Greenspan's cardinal sin was his failure to raise interest rates and hence the cost of borrowing, which encouraged reckless lending and speculation in the housing market. When that bubble burst, it brought the rest of the US and global economy down with it. On this widely held view, it was the Federal Reserve's misguided stewardship of the nation's money supply that lies at the root of the crisis - therefore, a correction in monetary policy (such as the Fed's repeated experiments in "quantitative easing") can go a long way of bringing us out of it.

You guessed it: James Livingston has no truck with the monetary explanation of crisis. He concedes that the bursting of the housing bubble was the proximate cause of the Great Recession, just as widespread bank failures and the subsequent contraction of credit was the proximate cause of the Great Depression of the 1930s. Then as now, however, looking toward the money supply for explanation of the deep roots of crisis confuses symptoms with causes, and leads to public policy measures that do little to bring the economy out of its malaise.

Livingston makes the case with an historical analogy:

"If the proximate cause of the Great Depression was a 'great contraction of credit,' a great expansion of credit should explain the recovery of 1933 to 1937, just as it should explain what is called the recovery of 2009-2010. But in the 1930s, the banks folded and never returned to the table. Instead they bought government bonds and parked their assets with the Fed, increasing their loans and discounts a mere 8 percent between 1933 and 1937, from a baseline close to zero - while in the current crisis, the banks are again sitting it out because the value of their 'assets' is still in doubt. In the earlier recovery, price inflation was minimal because even as industrial output doubled, so currency devaluation accounts for almost nothing there. In the current so-called recovery, both inflation and investment are absent and a 9 percent to 10 percent unemployment rate persists, but the money supply has more than doubled. So it's hard to see why economists believe the money supply or a 'financial fix' explains much of anything, either as a cause or a cure for economic crisis." (28)

If Livingston is right, and monetarist explanations of crisis are fundamentally misguided, then why do you think they retain their influence in mainstream economic and political discourse? What are some possible alternative explanations?

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