Anna Schwartz Indicts the Federal Reserve–Again

Economist Anna Schwartz devoted ten years to gathering and analyzing the data that went into her book with Milton Friedman, A Monetary History of the United States, 1867-1960. It was the empirical rigor of that book that reminded economists and central bankers of a truth many of them had forgotten—namely, that excessive growth of the money supply drives up prices. Thus Schwartz helped set the stage for the monetary tightening that tamed the tiger of inflation in the United States and Great Britain in the early 1980s. Schwartz hasn’t let up—she’s still working diligently at the National Bureau of Economic Research, where she has worked since 1941. The implication here is that her opinion on money and the economy matters far, far more than most people’s opinions because she knows what she is talking about.

Although she has shunned the media spotlight, Schwartz shares her insights on the current financial mess in the spring issue of City Journal. Here are some excerpts from that article.

This lesson of the recent past seems all but forgotten, Schwartz says. Instead of staying the monetarist course, Volcker’s successor as Fed chairman, Alan Greenspan, too often preferred to manage the economy—a fatal conceit, a monetarist would say. Greenspan wanted to avoid recessions at all costs. By keeping interest rates at historic lows, however, his easy money fueled manias: first the Internet bubble and then the now-burst mortgage bubble. . . .

Greenspan’s successor, Ben Bernanke, has followed the same path in confronting the current economic crisis, Schwartz charges. Instead of the steady course that the monetarists recommend, the Fed and the Treasury “try to break news on a daily basis and they look for immediate gratification,” she says. . . .

Bernanke is right about the past, Schwartz says, “but he is fighting the wrong war today; the present crisis has nothing to do with a lack of liquidity.” President Obama’s stimulus is similarly irrelevant, she believes, since the crisis also has nothing to do with a lack of demand or investment. The credit crunch, which is the recession’s actual cause, comes only from a lack of trust, argues Schwartz. Lenders aren’t lending because they don’t know who is solvent, and they can’t know who is solvent because portfolios remain full of mortgage-backed securities and other toxic assets. . . .

What about “systemic risk”—much heard about these days to justify the government’s massive intervention in the economy in recent months? Schwartz considers this an excuse for bankers to save their skins after making so many bad decisions. “The worst thing for a government to do, though, is to act without principles, to make ad hoc decisions, to do something one day and another thing tomorrow,” she says. The market will respond positively only after the government begins to follow a steady, predictable course. To prove her point, Schwartz points out that nothing the government has done to date has really thawed credit.

Schwartz indicts Bernanke for fighting the wrong war. Could one turn the same accusation against her? Should we worry about inflation when some believe deflation to be the real enemy? “The risk of deflation is very much exaggerated,” she answers. Inflation seems to her “unavoidable”: the Federal Reserve is creating money with little restraint, while Treasury expenditures remain far in excess of revenue. The inflation spigot is thus wide open. To beat the coming inflation, a “new Paul Volcker will be needed at the head of the Federal Reserve.”

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