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Wednesday, December 07, 2005

Ben Bernanke's Views Affected by Depression

Greg Ip of the WSJ has been doing some research on Ben Bernanke:

Lessons of the '30s: Long Study of Great Depression Has Shaped Bernanke's Views, by Greg Ip, WSJ: In 1983, Mark Gertler asked his friend and fellow economist Ben Bernanke why he was starting his career by studying the Great Depression. "If you want to understand geology, study earthquakes," Mr. Bernanke replied, ... "If you want to understand economics, study the biggest calamity to hit the U.S. and world economies." Mr. Bernanke's fascination with the economic earthquake never abated. ... Mr. Bernanke's interest in the Depression, which dates back to his childhood, is a guide to the evolution of his thinking. In particular, his groundbreaking research on how mistakes by the Federal Reserve compounded the catastrophe is likely to influence how he steers the economy... The Depression, he contends, has taught the importance of avoiding both deflation ... and inflation. It has also shown the threat that falling asset prices -- such as ... in housing -- and weakened banks can pose. Most important, it shows the damage the Fed can do when it follows wrong-headed ideas. ...

Even as a child, Mr. Bernanke ... was intrigued by the Depression. As a child of six or seven, he visited his maternal grandmother ... and sat on her front porch as she described life as a young mother during the 1930s ... Mrs. Friedman, whose husband taught Hebrew and worked in a furniture store, was proud they could buy new shoes for their children each year. But many neighborhood children had to go to school in tattered shoes or barefoot. "Why didn't their parents just buy them new shoes?" young Ben asked. Because their fathers had lost their jobs when the shoe factories closed, she said. "Why did the factories close down?" She replied, "Because nobody had any money to buy shoes." The circularity of her logic, which he later recounted in a textbook, bothered him yet illustrated a key puzzle of the Depression: Why was there so much idle capacity when there were so many unmet needs?...

In "A Monetary History of the United States, 1867-1960," [Milton Friedman and Anna Jacobson Schwartz ] argued that the Depression was far from inevitable, but brought about by an "inept" Federal Reserve. ... Mr. Bernanke read the book as a graduate student at Massachusetts Institute of Technology in the 1970s. "I was hooked, and I have been a student of monetary economics and economic history ever since," ... In 1979, Mr. Bernanke went to Stanford to teach economics. ... The 1970s' high unemployment and inflation had diminished the Fed's reputation, and new economic theories of "rational expectations" and the "real business cycle" held that the central bank could do little to affect growth and jobs. Mr. Bernanke nonetheless threw himself into studying the role of monetary policy in the Depression. ... While the Friedman-Schwartz theory had revolutionized thinking about the Depression, it couldn't fully explain the downturn's length or depth. Theoretically, neither deflation nor inflation ought to affect long-run growth or employment. After a while, people and businesses get used to changing prices. ...

Mr. Bernanke published his first major paper on the Depression in 1983. ... "My theory seems capable, unlike the major alternatives, of explaining the unusual length and depth of the Great Depression." The statement reflected an intellectual boldness that verged on cockiness. Messrs. Bernanke and Gertler began a lengthy collaboration refining what became known as the "financial accelerator" because it explained how the financial system could compound an economic downturn. The two had complementary roles, with Mr. Bernanke usually pushing for a bold statement and Mr. Gertler, he recalls, "telling him what's wrong with the statement." ... Mr. Bernanke's Depression research soon found a U.S. role. Some analysts had called on the Fed to rein in the galloping stock market in the late 1990s. But, ... Mr. Bernanke and Mr. Gertler said the Fed should raise rates if rising asset prices fuel inflation, but not to prick a bubble. "A bubble, once pricked, can easily degenerate into a panic," they said. When the bubble eventually collapses on its own, the Fed should cut interest rates to limit the damage to the financial system and the broad economy. ... As Fed chairman, Mr. Bernanke probably will not be talking much about the Depression, but it is unlikely to be far from his mind. ...

    Posted by on Wednesday, December 7, 2005 at 01:40 AM in Economics, Monetary Policy | Permalink  TrackBack (1)  Comments (18)

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    Mark Thoma directs us to a very nice article by the extremely, extremely good Greg Ip about Ben Bernanke and his thinking: Economist's View: Greg Ip of the WSJ has been doing some research on Ben Bernanke: Lessons of the '30s: Long Study of Great Depre... [Read More]

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