Fear Is Contagious

Ever the optimist, I was hoping that yesterday’s immediate, sharply negative, reaction to the FOMC statement and Ben Bernanke’s press conference was only a mild correction, not the sign of a major revision in expectations. Today’s accelerating slide in stock prices, coupled with continuing rises declines in bond prices, across the entire yield curve, shows that the FOMC, whose obsession with inflation in 2008 drove the world economy into a Little Depression, may now be on the verge of precipitating yet another downturn even before any real recovery has taken place.

If 2008-09 was a replay of 1929-30, then we might be headed back to a reprise of 1937, when a combination of fiscal austerity and monetary tightening, fed by exaggerated, if not irrational fears of inflation, notwithstanding the absence of a full recovery from the 1929-33 downturn, caused a second downturn, nearly as sharp as that of 1929-30.

Nothing is inevitable. History does not have to repeat itself. But if we want to avoid a repeat of 1937, we must avoid repeating the same stupid mistakes made in 1937. Don’t withdraw – or talk about withdrawing — a stimulus that isn’t even generating the measly 2% inflation that the FOMC says its targeting, even while the unemployment rate is still 7.6%. And as Paul Krugman pointed out in his blog today, the labor force participation rate has barely increased since the downturn bottomed out in 2009. I reproduce his chart below.


Bernanke claims to be maintaining an accommodative monetary policy and is simply talking about withdrawing (tapering off), as conditions warrant, the additional stimulus associated with  the Fed’s asset purchases. That reminds me of the stance of the FOMC in 2008 when the Fed, having reduced interest rates to 2% in March, kept threatening to raise interest rates during the spring and summer to counter rising commodity prices, even as the economy was undergoing, even before the onset of the financial crisis, one of the fastest contractions since World War II. Yesterday’s announcement, making no commitment to ensure that the Fed’s own inflation target would be met, has obviously been understood by the markets to signal the willingness of the FOMC to tolerate even lower rates of inflation than we have now.

In my post yesterday, I observed that the steep rise in nominal and real interest rates (at least as approximated by the yield on TIPS) was accompanied by only a very modest decline in inflation expectations (as approximated by the TIPS spread). Well, today, nominal and real interest rates (as reflected in TIPS) rose again, but with the breakeven 10-year TIPS spread falling by 9 basis points, to 1.95%. Meanwhile, the dollar continued to appreciate against the euro, supporting the notion that the markets are reacting to a perceived policy change, a change in exactly the wrong direction. Oh, and by the way, the price of gold continued to plummet, reaching $1280 an ounce, the lowest in almost three years, nearly a third less than its 2011 peak.

But for a contrary view, have a look at theeditorial (“Monetary Withdrawal Symptom”) in Friday’s Wall Street Journal, as well as an op-ed piece by an asset fund manager, Romain Hatchuel, (“Central Banks and the Borrowing Addiction”). Both characterize central banks as drug pushers who have induced hundreds of millions, if not billions, of people around the world to become debt addicts. Hatchuel sees some deep significance in the fact that total indebtedness has, since 1980, increased as fast as GDP, while from 1950 to 1980 total indebtedness increased at a much slower rate.

Um, if more people are borrowing, more people are lending, so the mere fact that total indebtedness has increased faster in the last 30 years than it did in the previous 30 years says nothing about debt addiction. It simply says that more people have been gaining access to credit markets in recent years than had access to credit markets in the 1950s, 1960s and 1970s. If we are so addicted to debt, how come real interest rates are so low? If a growing epidemic of debt addiction started in 1980, shouldn’t real interest rates have been rising steadily since then? Guess what? Real interest rates have been falling steadily since 1982. The Wall Street Journal strikes (out) again.


10 Responses to “Fear Is Contagious”

  1. 1 Steve June 20, 2013 at 6:48 pm

    I’m tired of hearing the depression analogies.

    It’s more likely that the Fed is steering us down the path of Japan 1990-2013.


  2. 2 maynardGkeynes June 20, 2013 at 7:14 pm

    The stock market is not run by economists, it is run by traders, and not just any traders, day traders. If at one extreme of economic understanding we have PhD economists, and at the other, video-gamers, Wall St. traders are about 90% of the way toward the latter. Why would anyone pay attention to the reaction of the the stock market? A true idiocracy. If you don’t believe me, watch the interviews with the traders on CNBC some morning.


  3. 3 Rob Rawlings June 20, 2013 at 7:18 pm

    Indeed , a very depressing day.

    I have a question: Is Bernanke really as clueless as would appear from today’s announcement or does he have a hidden agenda that if understood would at least explain the framework where cutting back on a policy that appeared to be working makes sense?


  4. 4 nylund June 20, 2013 at 11:10 pm

    “Today’s accelerating slide in stock prices, coupled with continuing rises in bond prices,”

    I think you mean bond yields not prices.


  5. 5 Diego Espinosa June 21, 2013 at 9:16 am

    Your post begs the question, when is it appropriate to withdraw stimulus? As I understand it, the thought seems to be that at NGDP trend levels, the need for stimulus disappears. Up until that point, the economy is stimulus-dependent. It’s as if you are throwing a ball up to a roof. If it doesn’t reach the roof, it falls back down. However, a ball decelerates as it rises. That deceleration is the analogy the Fed is using for tapering. If you don’t decelerate, then, of course, you run the risk of overshooting the roof.


  6. 6 Steve June 21, 2013 at 10:25 am


    Your analogy is actually a perfect description of the Fed: a “roof” or “ceiling”. You taper early if you want to get close to the roof/ceiling, without actually hitting it. So the Fed is aiming to move toward 2% inflation and/or full employment, but wants to slow down enough that we don’t actually get all the way there.


  7. 7 Christopher Mahoney (@christophermah3) June 22, 2013 at 1:44 pm

    I have trouble understanding why everyone is fixated on growth in MB, as opposed to growth in M2. It is clear that MB growth has almost no impact on M2, which is the M in the quantity theory, not MB. M2 growth has declined since QE3 started. The Fed needs to figure out how to get better control over M2 growth. QE hasn’t been the magic instrument.


  8. 8 Benjamin Cole June 22, 2013 at 8:38 pm

    I agree with Steve. We are doing a Japan, or maybe a Japan-lite.

    The Fed is targeting 2 percent inflation, while the BoJ seemed to be targeting zero or 1 percent inflation.

    So maybe the USA will not deflate, but just creep along. The next recession, though, will be ugly. It will start out with the USA nearly in ZLB. Then what?

    I see no option now but for the Fed to commit to ever higher levels of QE until certain targets are hit, in terms of real growth and employment.

    Inflation can take a back seat for a while.

    I still say we need to devise a better exit strategy for the Fed. Holding the bonds to maturity is interesting, but the Fed may still incur an “accounting” loss, one that makes no sense to me. This “loss” must be made up by US taxpayers.

    I still do not know how you can print money, buy bonds, sell the bonds, and end up in the hole. (I know how under GAAP, but not in the real world—or the world we need our Fed to operate in).


  9. 9 Tom Brown June 24, 2013 at 10:42 am

    David, I thought the following theory about what the Fed *might* be doing to be interesting:


    So the author doesn’t think “monetizing the debt” has been an appropriate description for QE since he believes there would be a robust market for Tsy debt even if the Fed were not engaging in QE, and he gives some evidence for that. But he surmises that perhaps the Fed itself has been under the impression that it’s been monetizing the debt and that this was required due to large deficits. Now that deficits are declining, it can afford to taper. This is exactly the opposite causality I’ve heard Scott Sumner present on various occasions: that is that increased fiscal stimulus will inevitably lead to a tight money policy (i.e. the Fed’s natural reaction to fiscal stimulus), whereas fiscal austerity leads to monetary offset. Here the hypothesized mechanism is that falling deficits (due to decreased fiscal stimulus and the sequester) has led to tighter monetary policy.

    It’s funny to me that both hypothesis depend on having a model for what’s going on in the minds of Ben Bernanke and the other board members!


  10. 10 JP Koning June 26, 2013 at 6:58 am

    David, I’ve very much enjoyed your last month’s worth of market commentary. Interesting to see how your thinking has evolved along with the market’s gyrations.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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