Fed’s monetary policies: did they help or hinder ?
A question that has been around for a while without a definitive answer is: have the US Fed’s monetary policies help or hinder the accumulation of public debt now over 90% of GDP?
The issue has a direct and indirect component. On the direct side, it is important to recognize that there was no “bubble” with government spending between 1997 and 2007, the decade preceding the Great Recession. The Fed’s own statistics ascertain that the tech bubble of 2001 and the real-estate bubble of 2007 were not accompanied by inordinate ramps in public spending; if anything, on a comparative basis, government debt did not keep pace with GDP growth in all these years. The problem with debt “explosion” lied elsewhere: the private sector.
It was indeed indirectly and in the private sector –mostly banks, but also consumers — that debt was allowed to rocket and outdistance GDP growth, in the years preceding the Great Recession.
This Great Recession was unlike any other experienced in recent memory: it was global (it touched every single country on the planet) and it was disastrous (with $30 trillion of lost wealth at its peak in March 2009). Moreover, most explanations were often dubious.
Pinning the problem on US subprime mortgages, as had been the immediate and impulsive explanation, fails to explain how this financial shrinkage spread all the way to Russia. After all, the latter had apparently no banks exposed to subprime or to other toxic paper.
The “mispricing of risk” argument proposed by former Fed chief, Alan Greenspan, did not address the dangerous role that the “shadow banking” system — the non-bank financial institutions that defined deregulated American finance — played in this debacle. They, and not commercial banks with deposit-based and regulated lending practices, are behind the $7 trillion “debt bubble” which erupted in the U.S. financial sector in the decade starting in 1997.
“The failure of laissez-faire U.S. capitalism”, suggested by the former E.U. President Sarkozy, does not illuminate how Europe’s largest universal banks have also been equally devastated.
It is now increasingly clear that the Great Recession of 2008 was rooted in world’s biggest credit surge in the history of banking. That surge, which happened primarily in the preceding decade, was facilitated by central banks in the western world – predominantly the US and the EU– of which the Fed still is the largest and the most influential. Whether central banks led their supposedly regulated commercial banks into this binge, or were led by them, is still unclear; but that is another topic altogether and will not be addressed in this paper.
To summarize, is there a cause and effect relationship between the Fed’s lax monetary policies and the huge US government deficits that followed them? The answer is indirectly affirmative.
Had the Fed pursued more consistent and disciplined monetary policies in the decade preceding the Great Recession, the bubbles of 2001 and 2007 could have been contained, preventing as a result the Great Recession and the Keynesian government overspending that followed it. The accumulated government debt is not a cause per se, but a consequence.
Let’s hope that our Fed has learned its lessons well: in economics — much like in medicine –prevention is vastly superior to rehabilitation, even if takes regulation to enforce it. But to get there, key concepts resting on the notions of “efficient markets” and “self-governance in banking” must be reexamined for their potential to misguide and undermine economic stability.
Moris Simson, former high-tech executive who now heads a strategy consultancy, is a fellow of the IC² Institute at the University of Texas