Wednesday, April 3, 2013

Ben Bernanke, the Rodney Dangerfield of Fed Chairmen

April 3, 2013

Ben Bernanke, the Rodney Dangerfield of Fed Chairmen

First it was 2012 presidential candidate Rick Perry, who wanted to deal with Ben Bernanke’s money-printing “Texas style”. Then 2012 presidential candidate Mitt Romney indicated that Ben Bernanke had better have his personal effects packed up and ready to move out of his Fed office by January 21, 2013. And now it is David Stockman, who is mad as Hell and won’t take it anymore (see Mr. Stockman’s rant in the March 31, 2013 op-ed section of the New York Times, “Sundown in America”), the money printing of the Federal Reserve under the chairmanship of Ben Bernanke being included in “it”. Similar to the late Rodney Dangerfield, Ben Bernanke just can’t get no respect.

I actually agree with much of the political-economic criticism vented by Mr. Stockman in his Times
op-ed.  Yes, government spending has expanded too much in the past four decades. And, to the point of my rant here, the Fed’s printing press was running too fast during most of the past four decades. When Fed Chairman Greenspan was being described as a monetary-policy maestro by Bob Woodward, yours truly was describing him more like the pied piper of Hamelin. And yes, when Ben Bernanke was a mere governor of the Federal Reserve Board under Greenspan’s chairmanship, he never once publicly dissented from Greenspan’s bubblicious policies. But let he who is without sin cast the first stone, Mr. “Supply-Side” Stockman. I believe in redemption. And I believe that the money-printing that Ben Bernanke oversaw after the failure of Lehman Brothers was and continues to be entirely appropriate unless a recession on the order of magnitude of that of 1929-1933 would have been viewed as desirable.

Let me begin my defense of Ben Bernanke’s Fed chairmanship post Lehman. Chart 1 shows the year-over-year percent changes in quarterly observations of the loans, leases and securities on the books of depository institutions – commercial banks, savings institutions and credit unions – from Q1:1960 through Q4:2012. The median year-over-year percent change in depository institution credit from 1960 through 2007, the year before Lehman failed, was 8.4%, as represented by the height of the horizontal red line in Chart 1. (As an aside, Mr. Stockman might want to take into consideration that the Reagan supply-side miracle might not have been so miraculous had it not been for the surge depository institution credit that coincided with it. Was it marginal tax-rate cuts or rapid growth in depository institution credit that worked economic miracles?)

But I digress. Notice that from 1960 through 2012, there have been only two occasions in which the change in depository institution credit was negative. The first occasion was in the early 1990s, at the time of the S&L crisis. You may recall that the economic recovery that started in the spring of 1991 was the first “jobless” recovery in the post-WWII era for the U.S. The second occasion in which depository institution credit contracted commenced in 2009, soon after the Lehman failure. The contraction in depository institution credit was more severe in the second occasion than the first.  As I have discussed in previous commentaries, reasonable people can disagree as to what the optimum rate of growth in depository institution should be and the 1960 – 2007 median growth of 8.4% might not be the optimum, but I would argue that a contraction in depository institution credit is sub-optimum. And that is what we were experiencing for the most of 2009, 2010 and 2011. At 3.4% year-over-year growth in Q4:2012, this remains a tepid increase in depository credit in the context of the past 50-plus years.

Chart 1

Enter the quantitative policies of Fed Chairman Ben Bernanke. Chart 2 shows the year-over-year percent changes of quarterly observations in Federal Reserve credit, here measured by the monetary base. The monetary base represents the cash reserves held by depository institutions and the currency held by the public, both of which are created by the Fed figuratively out of thin air. (This measure of the monetary base does not include the loans advanced to AIG following the collapse of Lehman Brothers.) When Mr. Stockman and others refer to the Federal Reserve’s money-printing operations, they are referring to the behavior of the monetary base. From 1960 through 2007, the median year-over-year change in the monetary base was 6.1%. From 1960 through 2008, the largest year-over-year change in the monetary base was 12.6% in Q4:1999, as the Fed greatly enlarged the amount of currency available to the public and depository institutions to accommodate the increased precautionary demand for such in anticipation of problems that might arise in connection with Y2K. (I still have tins of kippers that, to the amusement of my family, I stockpiled in December 2009.) But that 12.6% year-over-year increase in the monetary base pales in comparison with the 107.9% increase in Q2:2009. From the end of 2008 through the beginning of 2012, the monetary base has, with one quarterly exception, grown far above its 1960-2007 median rate of 6.1%.

Chart 2

Horrors? Perhaps not. Credit evaluation and political issues aside, there is no macroeconomic difference between the Fed providing credit and the depository institution system providing credit. Both create the credit they extend figuratively out of thin air. Thus, when either extends new credit, the recipient of that credit can increase its current spending and no other entity need decrease its current spending. When the Fed purchases Treasury securities in the open market, the cry goes up in some circles that the Fed is monetizing the public debt. Yet, if the depository institution system purchases Treasury securities, monetization alarm bells do not go off even though the macroeconomic impact is the same. When the depository institution system increases its net credit extension by granting more home mortgages, why don’t we hear that private debt is being monetized? In a sense, the depository institution system is an intermediary between the Federal Reserve and ultimate borrowers in the economy. Again, credit evaluation and political issues aside, in theory, the Fed could cut out the middleman, the depository institution system, and directly grant home mortgages, car loans and business loans to the private sector along with creating credit for government entities. What I am getting at here is that the sum of Fed and depository institution credit is what Mr. Stockman should be concerned with, not Fed credit in isolation.

Chart 3 shows the year-over-year percent changes in depository institution credit and the sum of depository institution credit and Federal Reserve credit (the monetary base) from Q1:1960 through Q4:2012. From 1960 through 2008, percent changes in the sum of Fed and depository institution credit and depository institution credit by itself does not differ much. It is starting in 2009 when the divergence in growth rates is magnified. For example, in Q2:2009, depository institution credit contracted by 0.5%, whilst the sum of depository institution credit and Fed credit grew by 7.0%. Recall, it was in Q2:2009 that Fed credit by itself grew year-over-year by 107.9%. Scary in isolation; not so scary when looked at in combination with depository institution credit. Fed credit began to explode in Q4:2008 after Lehman imploded. Yet, from Q4:2008 through Q4:2012, the latest complete data, there has not been one quarter in which year-over-year growth in the sum of Fed and depository institution credit has reached or exceeded the 1960-2007 median growth rate of 8.4% for depository institution credit by itself. In fact, from Q3:2008 through Q4:2012, the compound annual rate of growth in the sum of Fed and depository institution credit has been a mere 3.6%. During this same 17-quarter period, the compound annual rate of growth in depository institution credit by itself was 0.4%. Can you imagine how weak the pace in economic activity would have been post-Lehman had the Fed not sped up its “printing press”?

Chart 3

I suppose Mr. Stockman would have preferred the Fed’s policy in the early 1930s to Ben Bernanke’s. The Fed did speed up its “printing press” after the stock market crash of October 1929, but not nearly enough to offset the contraction in depository institution credit that took place. Chart 4 shows the year-over-year percent change in depository institution credit, Fed credit and the sum of depository institution credit and Fed credit for the semi-annual periods from 1929 through 1941. The shaded areas indicate periods of recession. Notice that during the 1929 – 1933 recession, there was an acceleration in the growth of Federal Reserve credit, but not enough to prevent the sum of Fed and depository institution credit from contracting. In the four years ended the first half of 1933, the sum of Fed and depository institution credit contracted at a compound annual rate of 7.5%. In that same time period, depository institution credit by itself contracted at a compound annual rate of 9.0%. The rebound in depository institution credit starting in the first half of 1934, which corresponded to a vigorous economic recovery, was due to several factors. The Banking Act of 1933 established the Federal Deposit Insurance Corporation. This greatly reduced the threat of runs on banks by depositors, which, in turn, reduced banks’ liquidity demand, enabling them to increase their lending. The Reconstruction Finance Corporation, established in early 1932, helped recapitalize the banking system, again enabling banks to increase their lending. And the Fed increased bank reserves, the “seed money” that the banking system could multiply into a greater amount of bank lending. The sharp spike in the growth of Fed credit/bank reserves that started in the first half of 1934 was related to President Roosevelt’s decision to raise the dollar price of gold – something that Mr. Stockman still is angry about. In 1936, the Fed began its exit strategy from its accommodative policy. From the middle of 1936 to the middle of 1937, the Federal Reserve began to “sterilize” some of the reserves that it had created earlier by doubling the percentage of cash reserves banks were required to hold against their deposits. This caused banks to contract their credit outstanding and the Fed did not offset this bank credit contraction with Fed credit expansion. This helped bring on the 1937 – 1938 recession.

Chart 4

In sum, I would argue that the “money printing” that Fed Chairman Bernanke engaged in after the failure of Lehman Brothers was entirely appropriate if the U.S. were to avoid a recession of the magnitude of that of 1929 – 1933. The Fed was merely creating some credit that only partially offset the contraction in depository institution credit. Despite the rapid growth in the Fed’s balance sheet starting in late 2008, combined Fed and depository institution credit has been growing at a subdued pace when compared with its behavior in the past 50 years. So, for now, let’s show Ben Bernanke some respect for how he has managed monetary policy after the Lehman failure. I have a hunch that there might be legitimate grounds to criticize the Fed chairman, whomever that might be, in the next few years as he or she executes the so-called exit strategy for monetary policy. If the exit strategy is not guided by the growth in the sum of depository institution and Fed credit, which by all indications it will not be, then policy mistakes will be made and Mr. Stockman can write another op-ed for the Times.

Paul L. Kasriel
Senior Economic and Investment Advisor
Legacy Private Trust Company of Neenah, Wisconsin
Econtrarian, LLC


  1. Thanks for another thoughtful piece. There certainly seems to be a fundamental schism between those who see the need for continued accommodative policy in order to forestall the severe costs of adjustment, and those who would just prefer to see the rot purged from the system, damn the consequences. I sympathize with today's central bankers, who are really left with no obviously good options. It's hard to see how developed countries can grow satisfactorily starting from this level of accumulated public and private debt, so some way will need to be found to reduce it to a manageable percentage of income over the coming years or decades. Inflating it away is arguably the "best" alternative, though experience suggests that it can be a difficult trick to pull off without nasty side effects.

  2. Thanks for that explanation. In the future, I would like to hear much more about the Fed's exit

  3. A thoughtful article, but I don't see things your way.

    You present the Fed under Bernanke as merely replacing what the commercial banking system normally does but which it temporarily was failing to do. My objections are these:

    1. What the commercial banking system had been doing was unhealthy... as evidenced by the dotcom bubble, the housing bubble and the fragility of the system that became evident in 2008. The banking system had persisted in unhealthy risk-taking because of confidence that the Fed would never let things get too bad. And the bankers were right; after the token sacrifice of Lehman, everyone else got rescued. So we still have a sick real estate market and a tangle of derivatives that makes it impossible to evaluate the condition of the big banks.

    2. Rescuing the banking system entailed rescuing incompetent management. The individuals who misallocated trillions are still in the capital allocation business.

    3. To mitigate the effect of (2), the government has tightened regulation of bank lending, i.e., we now have a credit allocation system consisting of proven incompetents supervised by government employees.

    4. While the Fed under Bernanke replaced the numbers normally generated by the commercial banking system, it didn't replace the function. Banks expand credit by making commercial loans that are spent in all sectors of the economy. The Fed expands credit by purchasing securities; the initial effects are concentrated in just one sector, the securities markets, which is a recipe for more bubbles.

    5. Unlike credit expansion by the banking system, credit expansion by the Fed entails an increase in the monetary base. Left to itself, a big increase in the monetary base eventually turns into a big increase in the public's money supply and then into rapid price inflation. The idea that the Fed will reverse the increase in the monetary base at the right and at the right pace, without choking off a weak economic recovery and without making the Federal debt impossible to service but just in time to prevent price inflation is a happy thought. It is not a plausible one.

    -- Terry Coxon, Casey Research

  4. Terry,

    I'm not sure that you or anyone else is reading these comments, but I want to respond to your point 5 above. I think there's a common assumption out there that the Fed must eventually reverse the extraordinary expansion of its balance sheet in the post-crisis period, but this isn't necessarily so. The permanent maintaining of a significantly larger balance sheet need not necessarily lead to massive uncontrollable expansion of broad money.

    Prior to the crisis, the commercial banking system would carry virtually no required reserves...I think the number was consistently less than $20bn, or well under 1% of total bank deposits. Now that total reserves are north of $1.8 trillion, our tendency is to assume that these will somehow be multiplied into countless new loans and deposits, resulting in an explosion of broad money. But what if we look at the expansion of reserves as a sensible response to the prior lack of sufficient reserves? It's administratively trivial for the Fed to convert the current level of "excess" reserves into "required" reserves, and begin to manage monetary policy by setting reserve requirements rather than interest rates.

    I agree that that the continued expansion of the Fed's balance sheet and zero interest rate policy is likely to be creating further economic distortions and bubbles. But I don't think that the problem is that the level of bank reserves has increased...that's arguably a step toward sanity after a period of excessive leverage in the system.