A few years back, at a conference to honour the 90th birthday of the great economist Milton Friedman, the keynote speech was given by Ben Bernanke, then merely a member of the board of governors of the US Federal Reserve .
Mr Bernanke, who had made something of a life’s work of studying the Great Depression and its causes, addressed the central contention in one of Professor Friedman’s analyses — that the economic disaster of the 1930s was essentially the result of an unforced policy error, a terrible series of mistakes by the Federal Reserve.
Mr Bernanke’s conclusion was surprisingly blunt: “You’re right. We did it. We’re very sorry. But thanks to you, we won’t do it again.”
At the time, the economist-turned-central banker’s observations seemed only a slightly more colourful assessment of historical events than policymakers are generally inclined to give. But five years or so later, with echoes of the 1930s apparently back in the air — last week, Alan Greenspan, Mr Bernanke’s predecessor, said that this could be the worst financial crisis in more than 50 years — the Fed Chairman’s promise then has taken on something of the appearance of a contractual obligation.
Certainly, the remarkable actions by Mr Bernanke and his colleagues at the Fed recently suggest that they take quite seriously the possibility that the current recession could turn into something really unpleasant and that, if disaster can be averted by policy action, at least they will not be found wanting.
The conventional Wall Street rap on Mr Bernanke is that he and his colleagues are of an academic mindset, hidebound by ivory-towered thinking, incapable of the agility needed to solve the deepening financial mess (unlike, presumably, those brilliant financial people who created the mess in the first place. In the immortal words last summer of the professionally irate Jim Cramer of CNBC: “They know nothing!!!”)
But consider this: since January Mr Bernanke has led the Federal Reserve in more radical, novel and imaginative directions than any of his recent predecessors ever dreamt up.
He has cut interest rates by more in one go (75 basis points) than at any time in the past 20 years (and for good measure, with last week’s cut, has done it twice).
He has come up with a bewildering alphabet soup of initiatives designed to pump liquidity into a cash-strapped financial system — Term Auction Facility (TAFs), Term Securities Lending Facility (TSLFs) and the rest.
He has deployed Fed money to help in the acquisition of one large investment bank (Bear Stearns) by another (JPMorgan Chase).
And, perhaps most dramatic of all, although it may sound a bit technical, he has used an obscure clause in the Federal Reserve Act to allow the Fed to lend at the discount rate to Wall Street brokers who have been barred by rule from borrowing direct from the central bank.
By most financial markets commentators’ estimations, this is the first time that this clause has been exercised since the 1930s – another telling sign that Mr Bernanke has done his Great Depression homework.
The question is no longer whether the Fed has been bold enough — though it could still be argued that it should have acted sooner. It is whether the Fed’s unprecedented measures will be enough to avoid even a mini-Depression. For the first time in a while, following last week’s eye-catching developments there were some truly encouraging signs.
Just when everybody was expecting the Crash of 2008, US equity markets had their best week since early February. The dollar rallied. Commodity prices eased. Credit spreads narrowed sharply.
Of course, it’s too early to say Mr Bernanke’s extremism has worked. For one thing, it is important to understand that the Fed is, in effect, fighting two separate fires with its actions and even if one is contained, the other could still spread or jump back to reignite the first.
The Fed’s liquidity measures, including orchestrating the sort-of rescue of Bear Stearns, are aimed at the crisis in the financial system
. The Friedman analysis of the Great Depression was that the Fed failed to step in and save banks from collapse. This caused a cascading run on financial institutions that resulted in the wiping out of something close to half the deposits of the banking system. This is something that Mr Bernanke seems especially anxious to avoid.
The Fed’s interest-rate cuts, meanwhile, are aimed at the broader economy.Though some expected the central bank to go further last week and cut rates by 100 basis points, it was clear that the policy-setting open market committee was nervous — two members opposed even the 75-point cut to 2.25 per cent. This seems unnecessarily cautious. If the economy is contracting as fast as it appears to be, the risk of inflation is going to diminish pretty quickly. The Fed is still well on course to take official rates down to 1 per cent in the next few months, or perhaps even lower — which would chalk up another first for Mr Bernanke.
In the end, though, saving the financial system and the economy will require more than Fed action. Markets won’t really stabilise until there is some firm indication from the Administration and Congress that there is big public money coming down the pipeline to bail out the battered housing market. Here, the politicians are still looking less radical than the technocratic policymakers at the Fed.
© Copyright 2008 Times Newspapers Ltd.