Clark Johnson wrote a really excellent book, Gold, France and the Great Depression, 1919-1932 on the international monetary disorders that produced the Great Depression, published by Yale University Press in 1997. The work stems from his doctoral dissertation at
Columbia Yale University. Although Johnson wrote his dissertation in the history department (at Yale), Robert Mundell (from the economics department at Columbia) was involved in supervising the dissertation, and the final product is obviously the work of a gifted and insightful historian/economist. Additionally, Johnson gives ample recognition to the sadly neglected contributions of Gustav Cassel and R. G. Hawtrey, who more than anyone else at the time and almost anyone else since, diagnosed and understood the monetary pathology that produced the Great Depression.
In a newly published paper (in the Miliken Institute Review), Johnson compares the monetary disorders producing the current Little Depression to the monetary disorders that produced the Great Depression some 80 years ago. He organizes his paper around six widespread myths about monetary policy, explaining how reality is almost exactly the opposite of the myths now paralyzing the implementation of effective monetary policy.
Myth #1: The Federal Reserve has followed a highly expansionary monetary policy since August 2008.
Myth #2: Recovery from recessions triggered by financial crises is necessarily slow.
Myth #3: Monetary policy becomes ineffective when short-term interest rates fall to close to zero.
Myth #4: The greater the indebtedness incurred during growth years, the larger the subsequent need for debt reduction and the greater the downturn.
Myth #5: When monetary policy breaks down, there is a plausible case for a fiscal response.
Myth #6: The rising prices of food and other commodities are evidence of expansionary monetary policy and inflationary pressure.
One of Johnson’s most important points is to challenge the notion that the near-term objective of monetary ease ought to be to reduce interest rates. The objective of monetary policy in current circumstances must be to raise prices and to increase inflation expectations. Doing so will increase estimates of profitability and encourage investment, causing interest rates to rise not fall. Focusing on reducing interest rates simply feeds into the pessimistic expectations that are holding down spending (both investment and consumption) inasmuch as expectations of low interest rates into the future can be validated only by low levels of economic activity or falling prices, both of which are deterrents to current spending and inducements to holding cash. Whether Johnson is right in endorsing Ronald McKinnon’s suggestion that the leading central banks cooperate to increase short-term interest rates immediately is not so clear, but he is almost certainly right to argue that the FOMC’s promise to keep interest rates low for an extended period of time was, whatever its intent, deflationary in effect. I would also quibble with his suggestion that rising commodities prices are entirely independent of monetary policy, even though he is correct to observe that rapid economic growth by China and other developing countries is an independent, and perhaps more important, factor in fueling increases in commodities prices. (And let’s not forget ethanol subsidies and mandates, either.)
At any rate, kudos to Clark Johnson for this timely contribution. Let’s hope that Johnson will provide further valuable insights on economic and monetary policy.
Update 10/28: I made a few changes in the first paragraph in response to Clark Johnson’s comment.