The report issued this morning by the Bureau of Economic Analysis that real GDP grew at only 1.3 percent in the second quarter and revising the estimate of growth in the first quarter down to 0.3 percent is really depressing (pun intended).
This reminds me of 1932. That’s when the Fed engaged in a program of open market purchases that had at most a minimal effect in slowing the downturn and reversing the slide in prices. The program was widely dismissed as a failure and evidence of the impotence of monetary policy in a depression. (Keynes had not yet invented the liquidity trap, but the idea that monetary policy is ineffective in stimulating a depressed economy because the interest rate channel is blocked predates Keynes. People mistakenly think that Keynes invented the “you can’t push on a string” metaphor, but it seems to have originated with Congressman T. Alan Goldsborough.) Scott Sumner has written about this episode in his (unfortunately still unpublished) book on the Great Depression, clearing up a lot of the confusion surrounding the program. It was not until FDR took office in March 1933 and immediately suspended the gold standard, raising the price of gold, that deflation was halted, and reflation and recovery began.
All current monetary policy is doing, intentionally or inadvertently, is inducing banks to hold reserves yielding more interest than Treasury bills. Looking at the amazing growth in bank reserves and the Fed balance sheet, people are amazed that banks are not lending despite all the “high-powered” money that the Fed has created. The current policy, like the half-hearted open market purchases of 1932 is a prescription for failure, but the failure is interpreted not as a failure to adopt an expansionary monetary policy, but as a failure of expansionary monetary policy. In 1933 FDR proved, despite the skeptics, that expansionary monetary policy does work. Why can’t we learn from FDR? Where are all the historians of the New Deal? Why aren’t they pointing out how FDR used monetary policy to start a recovery at the deepest point of the Great Depression?
HT Benjamin Cole