Thursday, November 27, 2008

We're All Keynesians Again

The whole point of Friedman and Schwarts' book was to blame the Great Depression on poor monetary management by the Federal Reserve.  Free markets work, without crisis, if only the government can not ruin everything.

Well, it looks like the pair provided necessary, rather than sufficient, conditions for avoiding the chaos resulting from massive deleveraging.  Substantial losses in asset values destroyed bank balances leading to a crisis in solvency, and a consequent loss in financial sector trust.  We don't have the liquidity problems that were present in the Depression--the Fed got that right this time--but it looks like the problems in both time periods are related to all sorts of other stuff.  As consumers get out of debt, they decide they want to retire with something, and stop spending, and then the economy crashes.  

This is a straightforward Keynesian stimulus that shouldn't be necessary anymore.  Cowen makes the argument that a fiscal expansion didn't help in the last Depression, but that's because FDR hampered his own stimulus with higher taxes.  I think it's hard to get away from the stimulus plans of Krugman and Larry "never saw a stimulas plan he didn't like" Summers.  

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