The Great Recession

The Great Lesson from the Great Recession by Mark Thoma

Mark Sadowski comments

But we didn't avoid the biggest mistake, which is to try to pop a bubble by causing a recession. 

In fact the conduct of monetary policy on the eve of the Great Depression and the Great Recession are eerily similar. Monetary policy was tightened to such an extent that the yield curve became persistently inverted in January 1928, 19 months before the Great Depression started: 

http://research.stlouisfed.org/fred2/graph/?graph_id=108333&category_id=0 

Similarly monetary policy was tightened to such an extent that the yield curve became persistently inverted in August 2006, 16 months before the Great Recession started: 

http://research.stlouisfed.org/fred2/graph/?graph_id=75581&category_id=0 

So far from being very different, it's "deja vu all over again".

The bank panics in the Great Depression started in small rural banks, so it was far easier to totally ignore it and to allow things to fester for a couple of years in those days. It wasn't until big urban banks started to fail, like the Bank of the United States in New York City in 1931, that the powers that be started to notice that there was financial crisis going on in their midst.
This time the banks are far larger, and thus harder to miss, especially since with the help of Bernanke and Paulson, they informed the Congress that they were holding the nation's economy hostage unless a TARP ransom was paid. So I'm not sure this is a sign of improved economic policy as much as it is a sign of more deeply entrenched and powerful interests demanding and getting first and best servings near the beginning of our depression, while the rest of us have to wait interminably for poor seconds. 

From 1933-37 the US pulled off the greatest economic recovery in history. Real GDP growth averaged 9.5% and unemployment dropped from 20.9% to 9.2%. And we know based on analysis by E. Cary Brown, Christina Romer, Barry Eichengreen etc. that the contribution of fiscal policy to the recovery was minor. Thus this was primarily a monetary policy led recovery. 

Why did monetary policy work so well back then despite the incredible odds against it?  Because by taking the country off the gold standard in April 1933, and allowing the price of gold to rise from $20.67 an ounce to $35.00 an ounce by January 1934, FDR effectively set a Price Level Target (PLT). This PLT was high enough to attract a large gold inflow from abroad which the Treasury monetized by issuing gold certificates to the Federal Reserve. The monetary base skyrocketed upward, reaching a maximum year-on-year rate of increase of 23.0% in February 1935, which essentially was the QE of its day. The economic recovery only came to an end when the decision to start sterilizing gold inflows in December 1936 meant prematurely removing the punch bowl, leading to the 1937 Recession. 

That was very much unlike our recent experience, where no new target has been set (it's just the same old 1-2% inflation rate target, yawn) and, until QE3, monetary base expansion has come in fits and starts. 

It seems to me, rather than evolving over time, monetary policy has devolved back into the "lunged" fish-like gold standard era ancestors from which it evolved, and seems utterly content to wallow in the miasmic swamp from which it came.