Saturday’s Wall Street Journal revealed that the Federal Reserve has been conducting numerous exercises to explore would it could to arrest the growth of asset bubbles as well as the risks inherent in doing such a thing (as opposed to nothing about it, which has been the standard operating procedure for some time).
That the Fed is thinking anew about how it should react to such a financial crisis is welcome news, but it’s wrong to think of it as a new development. After the 1929 stock market crash and the ensuing Great Depression, both of which were made significantly worse by the Fed’s sins of omission–and commission–before and during the crisis, the Fed realized it needed to assign itself this task.
In a book released this month, Wall Street, the Federal Reserve, and the Stock Market, published by the Center for Financial Stability, the economist Elmus Wicker, one of the world’s foremost monetary historians, argues that anticipating and pre-empting asset bubbles is a long overdue step for this Fed to take, and that is in fact merely a return to form.
Wicker, who, back in the 1940s studied the Great Depression under John Hicks, John Maynard Keynes’s most important acolyte, shows that the Fed learned its lesson from the disaster of the great depression, and after World War II was vigilant about nipping any incipient stock market bubbles in the bud.
Wicker observes that from the 1950s through the 1980s, the Fed acted at least twice each decade to pop what it perceived to be potential asset bubbles. At times it did so by boosting the discount rate, and other times it increased margin requirements. In a world where the financial press was much more somnolent than today, there was often little discussion in the media about the bubble or the Fed’s actions outside of Alan Abelson’s column in Barron’s.
In the 1980s this vigilance waned, beginning with Paul Volcker and continuing with Alan Greenspan. Volcker had more things to worry about than a stock market bubble–he was preoccupied with squeezing inflation out of the economy–but he was agnostic about the Fed’s abilities to identify and deflate asset bubbles. His successor, Alan Greenspan, was downright atheistic about such a notion: To assign itself such a task, Wicker quotes him as saying, sets up the Federal Reserve as knowing more about the state of the world than the collective action of millions of rational investors.
We managed to survive that stock market bubble with but a brief recession, although it’s undoubtedly the case that the bubble directed billions of dollars of capital to Silicon Valley that could have been much more productively used elsewhere (pets.com, anyone?) However, the housing bubble, which was ignited by the Fed’s expansionary monetary policy in 2001-2002 and abetted by a plethora of regulatory idiocy, resulted in the worst recession since the Great Depression.
Economists have never had much respect for history, considering it to be inferior to the quasi-scientific methodology the profession has come to adopt, and this perspective was a reason we were condemned to repeat history in 2008-2009. There aren’t many economists left who studied the Great Depression; Ben Bernanke happens to have been one of them, but the dean of this august but dwindling group is Elmus Wicker, who came out of retirement to give us, in his tenth decade, a modest yet perceptive view of the Fed’s responsibilities and its history of taming an overheated economy. That he managed to refrain from pulling a Robert Conquest when choosing a name for his book and merely titling it Wall Street, the Federal Reserve, and Stock Market Speculation speaks well of his temperament.
Ike Brannon is the president of Capital Policy Analytics, a consulting firm in Washington, D.C. This article has been updated.
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