What a Difference a Central Banker Makes

The excellent book Lords of Finance shows very clearly what happened with the major Central Bankers of the world during the Great Depression. In other words, for many different reasons – but mainly because of the fear of inflation or hyperinflation – the behavior of monetary aggregates and interest rates in the period 1929-1933 was entirely inconsistent with the dramatic declines of real economic activity. Only after Milton Friedman and Anna Schwarz wrote their classical monetary analysis of the Great Depression it became clear that there were major failures in the monetary policy responses to the economic crisis of the thirties.

Well, in the beginning of this decade, around 2002, Ben Bernanke presented a paper where he promised to Milton Friedman that his lessons were learnt and, consequently, Central Bankers now knew how to respond to any macroeconomic threat that could replicate the Great Depression.

And, as a matter of fact, after a certain short reluctance, which lasted perhaps three months (September-November 2008), Ben Bernanke was the leader of a major shift in monetary policy in the USA, whose consequence was a period of quantitative easing, leading to a multiplication by almost 4 of the size of the so-called “monetary base” between November 2008 and May 2009.

A new Great Depression was avoided with such bold measures. Unemployment and deflation worries were considered much more important than fears of inflation in the USA. And the USA economy was able to avoid depression and deflation, even though the year of 2009 after all indicated negative economic growth.

What is happening in Europe these days is precisely the opposite, unfortunately. So far, the attitude of Central Bankers in Europe is demonstrating that they are repeating many of the mistakes of the thirties, for fears of inflation or hyperinflation. In spite of Friedman’s monetary analysis, the major European countries – and of course the European Central Bank – are not ready to play with interest rate reductions and with quantitative easing through money supply growth.

Although we are talking now about European countries rather than US banks, the correct economic policy response should be basically the same: expand the money supply and the monetary base in countries like Germany and France, in order to buy bonds issued by Greece, Portugal, Spain, Ireland and Italy. We all know that Europe after all – in spite of the dream of a single currency – is not a single country, but what is at stake at this point in time is a systemic risk. There are certainly many “Lehman Brothers” banks in many European countries nowadays holding bonds issued by the so-called PIIGS.

Unless a Friedman-Bernanke policy is adopted as soon as possible, we can consider the euro as a dead currency. Unfortunately, due to old-fashioned economic policy responses, this crisis of 2010 might become as dramatic as the crisis of 2008. The new “Lords of Finance” are now sitting on the desks of many European Central Banks. It seems that, for them, a repetition of the German hyperinflation of the twenties raises much more fears than the Great Depression of 1929.

Surprisingly, such different policy responses, when we compare 2008 with 2010, seem to indicate that Central Bankers are still uncertain about the inflation-unemployment dilemma, particularly when and if such dilemmas include so many different countries, as in the case of Europe as opposed to the USA. What a difference a Central Banker makes…


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