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Market Monetarists: The Good, the Bad, and the Ugly

Summary:
Actually my title doesn’t really make sense; I couldn’t think of anything clever. I really liked this David Beckworth post, talking about the breakdown of the Fed’s “floor system.” In fact, I liked it so much that I based my article in the forthcoming issue of The Lara-Murphy Report on it. So score +1 for the Market Monetarists. However, in the article I had to remind the reader of conditions in the fall of 2008. I wanted to explain why the Fed was afraid to let its target rate fall further, and that’s why it “divorced” the fed funds rate from its asset purchases by instituting payment on reserves in October. In setting the scene, I reminded the reader that crude oil prices had hit 7 a barrel in July. I started to write out that the Fed had been tightening up

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Actually my title doesn’t really make sense; I couldn’t think of anything clever.

I really liked this David Beckworth post, talking about the breakdown of the Fed’s “floor system.” In fact, I liked it so much that I based my article in the forthcoming issue of The Lara-Murphy Report on it. So score +1 for the Market Monetarists.

However, in the article I had to remind the reader of conditions in the fall of 2008. I wanted to explain why the Fed was afraid to let its target rate fall further, and that’s why it “divorced” the fed funds rate from its asset purchases by instituting payment on reserves in October.

In setting the scene, I reminded the reader that crude oil prices had hit $147 a barrel in July. I started to write out that the Fed had been tightening up through the summer of 2008 because of the fear of price inflation. I thought that was the case, based on all of my reading of Scott Sumner et al. and their horror at the Fed’s focus on (price) inflation as the crisis hit.

But I wanted to be sure and get the exact figures, so I reviewed the details. And, uh, it doesn’t really look like you can explain the onset of the financial crisis by the Fed’s tight-money inflation fears:

In the chart above, the blue line shows the Fed target rate. The Fed began cutting rates back in September 2007, a full year before the financial crisis (the AIG bailout, Lehman failure, etc.). The Fed kept cutting rates, such that by May 2008, they were down to 2%–when they had been 5.25% the prior September.

Now it’s true, the Fed held rates steady from that point forward, but look at CPI. In July 2008, CPI was 5.5% higher than it had been a year earlier. (And the year/year CPI inflation rate had been near or above 4% from November 2007 onward.)

Look, I know that Scott Sumner is familiar with these figures–and I myself knew them better, back when we had just lived through this period. I’m just pointing out that at least in my case, constantly reading the Market Monetarists about how the Fed “tightened policy and causes the financial crisis” had lulled me into misremembering history.

There was a reason everybody thought Scott Sumner was crazy when they first heard his thesis, namely that Bernanke was engaged in the “tightest monetary policy since the Hoover Administration.” I think part of the reason his ideas have become more accepted, is that people have forgotten the actual sequence of events.

Robert Murphy
Christian, Austrian economist, and libertarian theorist. Research Prof at Texas Tech and author of *Choice*. Paul Krugman's worst nightmare.

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