James Forsyth James Forsyth

From Greenspan to Brown, policymakers were too keen to believe in their own supposed genius

Virginia Postrel’s column in The Atlantic this month makes for fascinating reading. In it, she highlight academic research that shows that the so-called ‘great moderation’ was not down purely to central banks or government policies, as central bankers and politicians wanted to think, but “changes in business practices that occurred for competitive reasons having nothing to do with macroeconomic goals.” As Postrel puts it, “The Great Moderation looks a lot like the staid 1950s, with better inventory management and more-flexible employment contracts.”

The Federal Reserve then became a huge part of the problem with its aggressive cutting of interest rates in 2001. Postrel points to research from John B, Taylor, of Taylor rules fame, that shows that there were approximately a quarter of a million more housing starts a year than there would have been if the Fed had kept to its normal procedure for determining interest rates.

Taylor’s critique of the handling of the financial crisis is extremely persuasive:

“To make matters worse, Taylor argues, once the financial crisis began in August 2007, policy makers and many Wall Street traders misdiagnosed the problem as a shortage of liquidity—something the Fed could address by making it easier for banks to borrow from the government. But the problem was really so-called counterparty risk: financial institutions couldn’t trust the securities they were buying from and selling to each other. To compensate for this risk, banks charged each other much higher interest rates.

“This was not a situation like the Great Depression where just printing money or providing liquidity was the solution; rather it was due to fundamental problems in the financial sector,” Taylor writes in a survey of his published research on the crisis.

Already a subscriber? Log in

Keep reading with a free trial

Subscribe and get your first month of online and app access for free. After that it’s just £1 a week.

There’s no commitment, you can cancel any time.

Or

Unlock more articles

REGISTER

Comments

Don't miss out

Join the conversation with other Spectator readers. Subscribe to leave a comment.

Already a subscriber? Log in