By August 2008, the unemployment rate had soared to 6.1%, up 1.7%
from the 4.4% low of the previous expansion. Since record keeping began
in the 1940s, the unemployment rate has never risen by more than 0.8%
without a recession. Not once. And it was already up 1.7 percentage
points, a clear indication of recession. Indeed by August the recession
was already almost as bad as the 1980 recession where unemployment rose
by a total of 2.1%.
The Fed knew all this when they met on September 16th, and they also
knew that Lehman had failed, that AIG was failing, that Fannie and
Freddie were in such dire straights that they had to be taken over by
the Federal government. So how did the Fed respond to this crisis?
Before I tell you let me point out that if you ask 200 economists, 90%
will tell you that they were "doing all they could". In fact, the Fed
did nothing at all. They sat around the table cracking jokes and
warning of inflation if policy got too expansionary. They did not cut
interest rates (from 2.0%). Then in early October they adopted interest
on reserves in order to raise interest rates---with the intention of
tightening monetary policy.
Marcus Nunes provides some excerpts from the infamous September meeting in the comment section of my previous post:
The 2008 "Dream Team"
SEPTEMBER 16, 2008 FOMC TRANSCRIPT
SELECTED QUOTES EXCERPTED FROM ROUNDTABLE DISCUSSION
MR DUDLEY
Either the financial system is going to implode in a major way, which will lead to a significant further easing, or it is not.
MR LOCKHART
But I should follow the philosophy of Charlie Brown, who I think said,
"Never do today what you can put off until tomorrow." [Laughter]
MR ROSENGREN
Deleveraging is likely to occur with a vengeance as firms seek to
survive this period of significant upheaval... I support alternative A
to reduce the fed funds rate 25 basis points. Thank you.
Mr HOENIG.
I also encourage us to look beyond the immediate crisis, which I
recognize is serious. But as pointed out here, we also have an inflation
issue. Our core inflation is still above where it should be.
MS YELLEN. I agree with the Greenbook's assessment that the strength we
saw in the upwardly revised real GDP growth in the second quarter will
not hold up. Despite the tax rebates, real personal consumption
expenditures declined in both June
and July, and retail sales were down in August. My contacts report that
cutbacks in spending are widespread, especially for discretionary items.
For example, East Bay plastic surgeons and dentists note that patients
are deferring elective procedures. [Laughter]
MR BULLARD
Meanwhile, an inflation problem is brewing. The headline CPI inflation
rate, the one consumers actually face, is about 6¼ percent
year-to-date...My policy preference is to maintain the federal funds
rate target at the current level and to wait for some time to assess the
impact of the Lehman bankruptcy filing, if any, on the national
economy.
MR PLOSSER
As I said, it is my view that the current stance of policy is
inconsistent with price stability in the intermediate term and so rates
ultimately will have to rise.
MR STERN
Given the lags in policy, it doesn't seem that there is a heck of a lot
we can do about current circumstances, and we have already tried to
address the financial turmoil. So I would favor alternative B as a
policy matter. As far as language is concerned with regard to B, I would
be inclined to give more prominence to financial issues. I think you
could do that maybe by reversing the first two sentences in paragraph 2.
You would have to change the transitions, of
course.
MR. EVANS
But I think we should be seen as making well-calculated moves with the
funds rate, and the current uncertainty is so large that I don't feel as
though we have enough information to make such calculations today.
MS PIANALTO
Given the events of the weekend, I still think it is appropriate for us
to keep our policy rate unchanged. I would like more time to assess how
the recent events are going to affect the real economy. I have a small
preference for the assessment-of-risk language under alternative A.
MR LACKER
In fact, it's heartening that compensation growth is coming in a little
below expected in response to the energy price shock this year. This has
allowed us to accomplish the inevitable decline in real wages without
setting off an inflationary acceleration in wage rates.
MR. HOENIG
I think what we did with Lehman was the right thing because we did have a
market beginning to play the Treasury and us, and that has some pretty
negative consequences as well, which we are now coming to grips with.
MR. ROSENGREN
I think it's too soon to know whether what we did with Lehman is right.
Given that the Treasury didn't want to put money in, what happened was
that we had no choice...I hope we get through this week. But I think
it's far from clear, and we were taking a bet, and I hope in the future
we don't have to be in situations where we're taking bets.
Mr. FISHER. All of that reminds me--forgive me for quoting Bob
Dylan--but money doesn't talk; it swears. When you swear, you get
emotional. If you blaspheme, you lose control. I think the main thing we
must do in this policy decision today is not to lose control, to show a
steady hand. I would recommend, Mr. Chairman, that we embrace
unanimously--and I think it's important for us to be unanimous at this
moment--alternative B
MR WARSH.
Those would be my suggestions to try to strike that balance--that we are
keenly focused on what's going on, but until we have a better view of
its implications, we are not going to act.
By late October the entire global economy was in free fall. The US
stock market had crashed and commodity prices were plunging. Indeed
almost all asset classes were plunging, except the US dollar, which was
appreciating strongly on the Fed's tight money policy.
On October 20,
Ben Bernanke was asked if the US economy was in recession:
Pressed to say whether he thought the economy was in a
recession, Bernanke refused to say. "We are in a serious slowdown in the
economy, which has very significant consequences for the public, and
whether it's called a recession or not is of no consequence."
But that caution did not stop him from again calling for fiscal stimulus:
WASHINGTON (MarketWatch) -- Another shot of fiscal
stimulus may be needed now to help the U.S. economy recover from what
could be a drawn-out slowdown, Federal Reserve Chairman Ben Bernanke
said Monday.
"With the economy likely to be weak for several quarters and with
some risk of a protracted slowdown, consideration of a fiscal package by
the Congress at this juncture seems appropriate," he told legislators
on the House Budget Committee. . . .
It was the second time this year that Bernanke had endorsed a
fiscal-stimulus program, a rare admission from the central bank that
monetary policy can't fix the economy by itself. . . .
Repeating the same general principles called for in January, Bernanke
said any new plan should be designed to be timely, temporary and
targeted.
The Fed chief suggested that Congress should include "measures to
help improve access to credit by consumers, home buyers, businesses and
other borrowers." Under questioning, Bernanke said Congress could
support the credit picture with guarantees, tax credits or even direct
lending.
I guess "monetary policy can't fix the economy by itself" if the Fed isn't even trying.
To summarize, in both January and September the economy was doing so
poorly that fiscal stimulus was called for. But when the Fed considered
whether it should do anything at the pivotal September meeting, all we
got were some lame jokes.
And even when the Fed finally got around to cutting rates, the cuts
were far too timid. At no time during the Great Recession was the Fed
doing it all it could.
PS. The October 20 piece also has an unfortunate example of Bernanke "reasoning from a price change":
He said that household-purchasing power should be boosted by
the recent declines in prices of oil and other commodities, calling the
trend a "bright spot."
Commodity prices were plunging precisely because the global economy was in free fall. Hardly a bright spot.
PS. Don't read this post as being about Bernanke, almost the entire
economics profession (including the FOMC) was basically on board with
what the Fed was doing, or not doing."
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