Fed Must Stay the Course on Monetary & Fiscal Policy, Alan S. Blinder

Alan S. Blinder, a professor of economics and public affairs at Princeton and former vice chair of the Federal Reserve, in an article in today’s NYT points out that monetary and fiscal policy strategy play a crucial role in determining current and future economic outcomes. Blinder emphasizes the fact that prematurely pulling back on fiscal and monetary policies can be extremely damaging and risky to the economy’s health. He suggests that “to avoid a replay of the policy disasters of 1936-37, both the Fed and our elected officials must stay the course.” One can hardly disagree with his logic. Here are a few excerpts:

From NYT: Contrary to what you may have heard from some doomsayers, 2009 is not 1930 redux.

But even if another depression is next to impossible, there is still the danger that next year, or the year after, might turn into 1936. Let me explain.

From its bottom in 1933 to 1936, the G.D.P. climbed spectacularly (albeit from a very low base), averaging gains of almost 11 percent a year. But then, both the Fed and the administration of Franklin D. Roosevelt reversed course.

In the summer of 1936, the Fed looked at the large volume of excess reserves piled up in the banking system, concluded that this mountain of liquidity could be fodder for future inflation, and began to withdraw it. This tightening of monetary policy continued into 1937, in a weak economy that was ill-prepared for it.

About the same time, President Roosevelt looked at what seemed to be enormous federal budget deficits, concluded that it was time to put the nation’s fiscal house in order and started raising taxes and reducing spending. This tightening of fiscal policy transformed the federal budget… — a swing of four percentage points in a single year. (Today, a swing that large would be almost $600 billion.)

Thus, both monetary and fiscal policies did an abrupt about-face in 1936 and 1937, and the consequences were as predictable as they were tragic. The United States economy, which had been rapidly climbing out of the cellar from 1933 to 1936, was kicked rudely down the stairs again

To avoid a replay of the policy disasters of 1936-37, both the Fed and our elected officials must stay the course.

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