Bernanke used monetary policy effectively to avert the repeat of the Great Depression



THIS WEEK, JANET YELLEN WAS SWORN in as the new chairperson of the United States Federal Reserve (Fed). She’s the first woman to chair the institution since its establishment in 1913. It’s a bumpy road ahead for Yellen, but I do not think things will be as tough as they were for her predecessor, Ben Bernanke, who chaired the Fed from February 2006 till last Friday.

In 2009, Bernanke was TIME Magazine’s Person of the Year. I recall reading the cover story at home in December of 2010, before I embarked on my journey to University of Cape Town, where I had enrolled for 2011 full-time honors in Information Systems. In reading that story, I learned of his brilliance.

When President George W. Bush appointed Bernanke to head the Fed in 2005, he had chosen the “best person to handle the financial crises”. Perhaps Bush had already anticipated that within the following two years, America’s economy would slip into the worst financial crises since the Great Depression of the 1930s.

Bernanke (Photo_Gary Cameron_Reuters)
Ben Bernanke, who chaired the Fed from February 2006 till last Friday. (Photo: Gary Cameron/Reuters)

Ben Bernanke is one of the smartest Americans. He’s a Great Depression scholar, and had written extensively about the subject. He had studied central banking since he was a graduate student at Massachusetts Institute of Technology. According to the New York Times, “he knew more about central banking than any economist alive”. In his book titled “The Return of Depression Economics”, Paul Krugman points out that when Bush appointed Bernanke, he had chosen the most suitable candidate for the job. Because Bernanke understood the tragic monetary policy mistakes that were made by the central bankers of the 1930s.

I first encountered Bernanke’s work when I was a third year student at Rhodes University. I was writing an essay on the Great Depression when I bumped into his essays on the similar subject at the Rhodes library. He understood how the Fed’s tight monetary policy prolonged the Great Depression. Such mistakes would not be repeated again.

Most, if not all, renowned economists agree that tight monetary policy worsened the Great Depression. In his best-selling book, Capitalism and Freedom, Milton Friedman shares an interesting statistic: between late 1930 and early 1933, monetary stock declined by 33%. He argues that the Fed failed to pump reserves into the banking system to avoid a collapse in money stock. This collapse culminated in failure of many banks. In simple terms, the banks were short of money, and the impact on the economy was devastating. It is this reason that, in his entire career, Friedman argued that the Fed caused the Great Depression.

The economic turbulence of the 1930s taught economists many lessons. For Bernanke, the financial crises of 2008 challenged him to apply the lessons and his knowledge on how to avert the repeat of the Great Depression. He used every mechanism available to ensure sufficient money stock in the economy. In August 2007, the Fed cut the discount rate to ease growing strains in the financial markets. One mechanism that caught my attention, used by Bernanke to bolster the economy, was what they called “quantitative easing” or “QE1”, which he launched in November 2008. According to Business Insider, the plan at the time was ”to buy up to $500 billion in mortgage-backed securities (MBS) and $100 billion in housing agency debt”. That QE1 was not the last, under Bernanke it became a series of “quantitative easings”. In March 2009, the Fed announced “it will expand QE1 with additional $750 billion in MBS, $100 billion in housing agency debt and $300 billion in Treasury securities”, according to the Business Insider. They further expanded QE1 twice in 2012. In addition to this quantitative easing, short-term rates were kept near zero.

The aim of this expansionary monetary policy was to ensure liquidity in the banking system and to encourage private and corporate lending. So money was easily available, so that consumers can have access to it and spend it to keep the economy productive.

I do not necessarily recommend the bailout of private businesses, but when it comes to financial institutions like banks, I think the repercussions of letting them fail are very calamitous. During the 2008 recession many American banks were bailed out. Unlikeable to some, but perhaps the right thing to do to avoid the banking crises.

I cannot confidently say that Bernanke did an excellent job. But overall, he applied the lessons learned from the economic headwinds of the early 1930s. He did execute the Fed’s responsibilities; used monetary policy effectively to avert the repeat of the Great Depression. He left the American economy on the right track: unemployment continues to slowly decline, positive growth (which is something that has been very hard to achieve for many industrialized countries post 2008 financial crisis), the housing market is getting back on its feet and the stock markets are at record high. He now works for Brookings Institution as a distinguished fellow in residence, and plans to work on a book about his time at the Fed. I wish him only the best. PM

To God be the Glory.

Ø Youth Coordinator at Free Market Foundation South Africa

Views expressed here are my own; they have nothing to do with Free Market Foundation South Africa