Joan Robinson and Anna Schwartz

I probably picked on Anna Schwartz enough last winter, but since readers keep sending me her new editorial in the NYT, I suppose I should say something. Here is her explanation for why monetary policy was easy last fall:

Let me begin with the former. It is standard practice for a central bank like the Federal Reserve to ease monetary policy to combat a recession, and then to tighten it as recovery gets under way. Mr. Bernanke so far has only had to do the first half, and has conducted a policy of extreme ease. The Fed’s Open Market Committee cut the federal funds rate in October to 1 percent from 1.5 percent, and then in December to a range of zero percent to 0.25 percent.

Extreme ease? If this quotation sounds familiar, it may be because the argument used is essentially identical to an earlier Joan Robinson analysis of the German hyperinflation:

“An increase in the quantity of money no doubt has a tendency to raise prices, for it leads to a reduction in the rate of interest, which stimulates investment and discourages saving, and so leads to an increase in activity. But there is no evidence whatever that events in Germany [in the early 1920s] followed this sequence.”

So money couldn’t have been easy when German prices were soaring, because nominal interest rates weren’t that low. And similarly, money couldn’t have been tight last fall as NGDP was plummeting, because nominal interest rates were low. What puzzles me is that in Anna Schwartz’s description of Fed policy, there is no mention of the decision to pay interest on reserves. (Recall that in their Monetary History, Friedman and Schwartz argued that the Fed’s decision to raise reserve requirements in 1936-37 was a mistake that contributed to the severe recession of late 1937.) Instead she makes the following puzzling assertion:

What drove down the funds rate was the Federal Reserve’s decision to increase its depository bank reserves. Bank reserves have been rising since Sept. 17, as the Fed purchased securities and financed loans. When the Fed committee cut the rate to zero, it was merely ratifying the de facto rate.

If this were true, then why would the stock market have responded so strongly to the December announcement? In fact, rates had not already fallen to zero, as banks were able to earn interest on excess reserves.

After engaging in some circa 1938 Keynesian analysis of monetary policy, she suddenly switches to Austrian-style analysis:

Why is easy monetary policy such a sin? Because in such an environment, loans are cheap and borrowers can finance every project that they dream up. This results in excesses, and also increases the severity of the recession that inevitably follows when the bubble bursts.

I won’t say anymore, as I devoted an earlier post showing how Anna Schwartz was now making the sort of Austrian arguments that she and Milton Friedman ridiculed in their Monetary History. And then there is this perplexing passage:

Let’s move on to the sins of omission. After 2007, the Federal Reserve clearly observed that the mortgage loan industry was being transformed into an issuer of securities backed by a pool of mortgages of varying quality. Yet the Fed at no point clearly warned investors that these new instruments were difficult to price. (These securities were backed by everything from top-quality mortgages to subprime ones, and it was difficult to determine what value to assign to different mortgages.)

Partly as a result of the Fed’s silence, investors who loaded up their balance sheets with these securities were ignorant of the great risks of trying to sell assets that are difficult to price. Other new instruments, like derivatives, were not risk-free, although the market became enamored of them.

The Fed is the manager of markets. There is thus every reason to expect that it would see the problems that these new instruments were likely to create for normal transactions, and speak up about them.

I’m confused. Does this mean that all the big Wall Street banks that lost billions on bad mortgage bonds aren’t really at fault because the Fed didn’t warn them that the loans they were buying might not be repaid? Isn’t that regulatory paternalism taken to an extreme?

So what does this short editorial add up to?

1. The old Keynesian argument that low interest rates mean easy money, even if prices and NGDP are falling (as in the early 1930s.)

2. The Austrian argument that low interest rates inevitably blow up bubbles and cause recessions, even if there is no sign of inflation (as in the 1920s.)

3. The view that if investors make mistakes this shows that the government didn’t properly “manage” the markets, and warn them not to make foolish investments.

What would Milton say?

I still love her Monetary History. And I suppose Joan Robinson and Anna Schwartz are still two of the three greatest female economists of all time. The third? Obviously Deirdre McCloskey.

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