Meltzer on Inflation
Feb 23 2009

Allan Meltzer, of Carnegie Mellon University, talks with EconTalk host Russ Roberts about the current state of monetary policy and the potential for inflation. Meltzer explains why inflation hasn't happened yet, despite massive increases in reserves created by Fed policy. Then he explains why inflation is coming and why it will be politically difficult for the Fed to stop it. Meltzer also analyzes the Japanese experience in recent years and talks about why so many investment banks overreached and destroyed themselves.

Explore audio highlights, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Johan Sigfrids
Feb 23 2009 at 9:36am

I wonder how many governments around the world are counting on big inflation after this downturn ends to help offset the public deficit that is now being run up by all the public spending under the name of stimulus.

Steve Spiller
Feb 23 2009 at 1:28pm

Russ – I was less than satisfied with Allan Meltzer attributing excessive risk taking to a Bank management believing that they thought they were “too big to fail”.
It fits better with my idea of their motivation to recognize that Bank management (1) only looked out short term for their compensation while placing long term bets (30yr mortgages)for the Bank, and (2) they were employees of a corporation, therefore not exposed to personal liability when things went wrong.

If Lehman and Bear Stearns had remained partnerships, would they have taken that risk?

Am I all wet?

Feb 23 2009 at 3:04pm

I agree with Steve Spiller but I wonder if the idea that investors are more diversified that management and so should encourage risk taking had some effect also at least the effect that made investors not worry as much about bad incentives.

Feb 23 2009 at 3:45pm

Meltzer is logical and persuasive, but one mystery remains for me. Meltzer argues that it’s not that big a deal for even a big bank to fail. Equity (and debt?) owners lose everything, but depositers and customers barely notice a thing because the bank’s assets continue to be managed by the same employees (minus the old management)under the new management. But if that’s true, why is the “too big to fail” doctrine so entrenched? Why the universal fear of “systemic” effects? Have past Fed chairman and other policy makers just been deluded or ignorant about the mechanics of bank failure? Or what?

Feb 23 2009 at 4:07pm

VTW if Greenspan as well qualified as he is just made a mistake and it lead to this, is that not an argument that the Fed chairman is just too powerful and that we need free banking or at least 5 or six independent competing fed reserves?

Feb 24 2009 at 12:10am

I thought it was an interesting podcast. Meltzer placed a lot of his theory around the doctrine of too big to fail though, with little explanation of where this precedent was set. The only example he gives for not letting banks that were too big to fail fail is LTCM, which ironically was not a bank. And of course as Russ pointed out, it wasn’t really a bailout, it was all done with private money. Meltzer thinks they were coerced, but what evidence is there? Bear Stearns was in the room the whole time and walked out of self-interest. How were the banks coerced by the Fed?

Also, to lend credence to his point Meltzer cites the “Greenspan Put,” but he mischaracterizes it. The Greenspan put is the idea that Greenspan lowers rates when the value of assets fall, maybe excessively. That is a lot different than a bailout though, as it is often just standard monetary policy. [Greenspan Put]

Feb 24 2009 at 1:27am

American banks might have taken excess risks because they thought they would be considered too big to fail, but what about banks in the rest of the world? Does the same explanation apply?

Feb 24 2009 at 9:43am


Fantastic podcast…enjoyed listening from beginning to end!

The only question that I would have asked Prof. Meltzer was given his prediction of inflation worse than the 1970s, what should individuals be doing now to prepare for it? Conventional wisdom says to buy gold, but I would have been very interested in his opinion.

Feb 24 2009 at 12:17pm

This talk of inflation never mentions that a fundamental shift in consumption to savings will reduce final demand for goods and services. if we have a 14 trillion dollar economy that is 70% consumption with a savings rate of 0% what happens when you get a 10% savings rate? you lose a trillion dollars in demand for goods and services. that will keep incomes from rising and excess capacity will have to be reduced resulting in stagnate to lower final prices. the inflation argument your guest just made assumes if you gave everyone a million dollars they’d actually go out and spend it. but if everyone sticks it under the mattress what happens? i’m not talking about investment because there isn’t going to be and demand for anything but cash… not equity or other real assets.

inflation is not a problem for now and for years to come. money being created barely replaces money lost in the last year

Kevin Harris
Feb 25 2009 at 10:48pm

I find the argument that the government is creating surplus liquidity that will translate into inflation once sentiment turns positive to be persuasive. But is not also true that there is currently a great deal of ‘negative liquidity’ that must be counteracted before that is a real risk? Also, is it not also likely that at least in the medium term, individuals and firms will desire to maintain higher levels of reserves than in the recent past even if the mood turns positive?

Feb 26 2009 at 9:48am

People go betting not because they think they will be bailed out, but because they believe they can win big.
Right incentives – easy credit, chance of a bailout, watching a disguised conman winning quick and easy (freddie and fannie?), low personal risk (high personal gain vs. loosing someone else money) quickly multiply number of gamblers.

Feb 26 2009 at 11:02pm

So, Meltzer says the banks are sitting on a big inflation time-bomb of surplus dollars. These dollars will be released into the economy in a big flood as soon as the banks gain some confidence in the economy and each other.

The simplest answer to the problem is to increase reserve requirements to prevent the banks from releasing it all at once. What negative effects would that have?

Mar 3 2009 at 9:54pm

So, inflation (as TLenze put it) is a time bomb waiting to happen. Correct me if I’m wrong, but it seems like a good time to run up as much business debt as possible, ie investment real estate and capital investments in my business, etc. The inflation will devalue my debts when it hits, as I’ll be able to pay it off with inflated/devalued dollars. Thoughts?

Mr. Econotarian
Mar 9 2009 at 7:58pm

Melzer’s inflation worries are backed up by this report:

“Between mid-September and December 31, 2008, the U.S. monetary base increased from approximately $890 billion to $1,740 billion, doubling in a little more than 3 months…

…The key is that the Fed will have to drain reserves when the economy begins to recover if it is to prevent a rapid acceleration of inflation.”

So how good do you think the Fed is at market timing? I’m thinking about buying some gold for once.

Mar 11 2009 at 10:51am

This has been my favorite discussion on the current crisis yet. I listened to it on the metro and was so excited by the second half of the episode that I literally ran from the metro to my apartment to discuss the ideas with my wife.

Thanks for consistently lining up such great guests and engaging them in such thoughtful discussion!

It’s pledge time on my local PBS stations and I whenever I hear a plea I think how great it is that I’ve been enjoying EconTalk for more than a year now and I’ve never been asked for money. That very lack of request makes me want to give all the more. Is there a way to do that or a need for these kinds of donations? If not I’m happy to keep free riding on Russ’ hard work and Liberty Funds Inc’s bandwidth.

Mar 12 2009 at 4:19pm

In the transcript at about 21:30, Meltzer thought a place to look for early signs of inflation was the spread between real and nominal interest rates. Can anyone suggest a web site where I can monitor this? And sorry for the beginner question, but what am I looking for the spread to do? Thanks, a great show!

( Meltzer’s quote)
What measures should we be looking at? Money supply and spread between real and nominal interest rates. Where will that show up first? Spread between real and nominal interest rates; moved quite a bit, no longer anticipating deflation. Which interest rate? Ten year bonds, five year bonds.

Mar 16 2009 at 11:56am

I really enjoyed the program. I am certain that is people see the economy turn around that the spending rate will continue on at 70% and the savings rate at 0%. After all, we lived like that for years.

I am interested in what tools the Fed has against inflation. Are interest rates the only tool to curb inflation? Also, is it possible to have an inflationary economy while also being in a recession? Considering we are in a global economy, I can see scenarios of foreign economies driving up prices of goods while our economy lags because of a lack of industry.

Love the show.

Mar 19 2009 at 9:13am

“The simplest answer to the problem is to increase reserve requirements to prevent the banks from releasing it all at once. What negative effects would that have?” (TLenze)

Because if you increase reserve requirements, banks are forced to lend less money. The entire point of giving them the money in the first place was so that they’d lend more.

Mar 20 2009 at 7:14pm

To TIM: money being created barely replaces money lost in the last year

This money wasn’t lost, it didn’t magically disappear. It is money that has become mostly (and simply) uninvested. Ultimately, it will become reinvested again, and the money supply will then be tilted horribly in the wrong direction. Inflation, at the most elementary level, will be a realized result of this.

To GRAHAM: Because if you increase reserve requirements, banks are forced to lend less money. The entire point of giving them the money in the first place was so that they’d lend more.

Banks lend money for profit, this was made transparently obvious by the fact that when Government money ostensibly given in order to be lent, was instead used to erase debt or to buy competition. My notion is twofold: Raise interest rates, make lending more profitable, and in the process stave off inflation.

My opinion is uninformed as I’m not an economist, but my opinion (for what it’s worth) is that the Government could tighten some requirements and still leave responsible lending an opportunity to be profitable and desireable.

Mar 23 2009 at 10:17am

Hi Russ,

Great podcast. Meltzer seemed to focus on mgmt when the “Greenspan Put” may also have had a significant effect on bondholders. By reducing their perception of risk, bondholders may have been more willing to fund what they knew were risky plays.

I also wonder why the bondholders aren’t more of a key to the resolution of this problem. Either by a partial conversion to equity or by the gov’t buying up bonds in the open market (below par) and using their conversion to equity as a capital injection. Seeing them get 100% as a result of taxpayer injections is just depressing.


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Comments are closed.

About this week's guest: About ideas and people mentioned in this podcast:

Podcast Episode Highlights
0:36Intro. [Feb. 11, 2009] History of the Federal Reserve, vol. II forthcoming. Mysteries: What is going on? Monetary policy appears to be expansionary by some measures. True? What measures should we look at. True, never been a period like this. Fed buying illiquid assets. Has to do things about current crisis; doesn't have to neglect the future. What is the Fed doing? Added 1.5 times to its balance sheet; reserves growing in the 1000s of percent annual rate; money M2 growth at 20% annual rate for the last 6 months. It's buying assets, such as Treasury Bills, commercial paper, mortgages, including $29 billion of unsaleable Bear Sterns assets. Paid for those assets by issuing reserves--printing money. Who is holding those reserves? Banks. People are very fearful, worried there will be a collapse. Fed encouraged that fear because it never in its 95 year history had a policy of lender of last resort, so it went in the spring it helped Bear Sterns; people thought it would behave as it always has behaved, which is to bail out large banks. Then it let Lehman fail, complete reversal of its policy for the last 40 years. Policy change not necessarily objectionable, but it came unannounced, which created fear. Portfolio managers didn't know what would happen next, so held cash, to wait and see. What are the banks doing with the reserves? Holding the assets. Fed pays interest on the reserves at a very low rate. Within a bank, there is a reserve requirement--a minimum amount of capital to have on hand. Corporations holding large cash balances. People don't know what the government is going to do; the Paulson treasury changed its mind, the Fed has done things it's never done before; want to protect yourself. Fed it also holding Treasury Bills. It's buying up mortgages. Traditionally if the Fed wanted to increase the money supply--lower interest rates--it would intervene in the Treasury market, federal funds rate, rate that banks charge each other overnight, buying up Treasuries. If it wanted to do decrease the money supply, it would do the reverse, selling Treasuries, raising the federal funds rate. Recently it's gone beyond Treasuries, buying up other assets, injecting cash into the system. Banks and people all over the world are buying Treasuries with the cash the Fed is supplying. It is also supplying a lot of cash--reserves--to foreign Central Banks so foreigners can buy Treasury bills and support the dollar.
8:43What does it mean to say the policy is expansionary if the money is coming right back out to buy up Treasuries? Some of it is showing up as growth in money, M2. Most of the reserves are being held, potential for expansion. If it's held in the form of Treasuries it is expansive? Yes, because they are liquid. Member banks have a much more liquid balance sheet than 6 months ago. Measure of their fear. Traditionally if the Fed injected cash much would be lent out. Now there is so much caution that banks are holding onto that money, and investing in Treasuries which are relatively safe. Holding both cash and Treasury Bills. Both will be available and will be exchanged for productive assets when the fear lessens. Foreign Central Banks coordinating with the Fed. Fed has the swap line, lending reserves to foreign Central Banks in exchange for claims on those banks. Foreign banks operate in this country and need U.S. dollars. What about foreign Central Banks? They are expanding their money supply, but not as much as the U.S., trying to stimulate their economies.
12:30Federal Government is spending more than it takes in in taxes. When we talk about people turning to Treasuries, there are two things going on. They are bidding on the existing stock of Treasuries, driving down the existing return, which is why Treasury rates are very low. But at same time, Federal government is issuing new Treasuries, borrowing; running a $1.2 trillion deficit for the year, before we begin to fund the new stimulus plan. Federal Government is flooding the world (though small relative to world's capital stock, large relative to amount that will be available from those sources) and also printing money to help fund those purchases. Bottom line is money supply has grown dramatically and will grow even faster as confidence is restored. Ironically, the biggest worry right now seems to be deflation. That's changing. There is a difference of opinion about what is meant by "inflation." Milton Friedman: sustained rate of increase in a broad-based price index. Other economists, especially Keynesian economists, have defined it as any increase, even a one-time short-term increase. Falling oil and food prices cause consumer price index moving negatively, but they are one-time changes in the price level, not persistent or likely to go on. Monetarist approach: persistent and sustained. Distinguish between relative price changes and general price changes. Oil price decline is a relative price change that will make the price level go down as a one-shot matter but only temporarily. If money supply is growing that dramatically, why is that not showing up as sustained higher prices that continue to grow? First principle: government controls rate of growth of the money stock and the public decides how much they want to hold. Will change when public's confidence is restored; then pressure on Federal Reserve at that time will be to mop up the enormous increase of reserves. Normally, as inflation starts to be realized, the response of the Fed will be to try to get the reserves out of the system. But this time, they will be under pressure by Congress, Wall Street, business community saying the recovery is just starting, prices aren't rising all that much. In the 1970s the Fed knew it had an inflationary policy and vowed it wouldn't do that. But when the unemployment rate got to 7%, about where it is now, they would say they have to do something about the unemployment rate. That's how we got the Great Inflation, not ended until Paul Volker decided to follow what he called practical monetarism, not paying most attention to the unemployment rate but focusing on the inflation rate. Earlier podcast. Story in WSJ today, dispute within in the Fed about whether and how much they should buy long-term securities. Those concerned about inflation vs. those concerned about political pressures. Long-term securities: Central Banks consider their principle responsibility to not create inflation; doesn't mean they are not concerned about unemployment, but always have their eye out to see that they are not creating inflation. One way they do that is to keep their balance sheet so that they can buy and sell the securities that they own. Long-term securities are not easy to sell because they fluctuate in price so much. By buying long-term securities it is buying things it will be unlikely to sell. In the 1940s, period before the war and post-war, Fed bought long-term securities and made sure the interest rate did not go above 2.5%; produced a big inflation.
21:30The coming inflation is going to make the 1970s look like a picnic--a picnic on a rainy day. Who would disagree with you? There are people on Wall Street, most of the people at the Fed, particularly at the Board of Governors, have their sights set on the shorter term. Meeting at the Board in 1967: group called the Consultants, Friedman and Meltzer at same meeting; Friedman turned to McChesney Martin, Chairman at the time, and said: You've done a good job of handling the most recent mini-recession, but now making big mistake, putting the money back in. McChesney Martin didn't think much of economists but nice man, nodded his head. After meeting, Friedman said to Meltzer, "I think he heard me." Meltzer: "No, I think he understood you." Then inflation for 14 years. Why are interest rates currently so low? Shouldn't they be higher, reflecting expected inflation? Because people all over the world are fearful. But they've moved up quite a bit in the last month. What measures should we be looking at? Money supply and spread between real and nominal interest rates. Where will that show up first? Spread between real and nominal interest rates; moved quite a bit, no longer anticipating deflation. Which interest rate? Ten year bonds, five year bonds. Any arrows left in the monetary quiver? People argue that the Fed's main instrument is the Federal funds rate, but the Federal funds rate is now close to zero, so it's like pushing on a string. Nothing it can do. Not true. Quantitative easing: they're going to buy longer term securities and they're not going to pay attention to the Federal funds rate because it's so low and they can't make it lower; so they'll put out reserves against other assets. But all easing is the same--they are buying assets. Totally false that they have no weapons left. But as long as there is an atmosphere of fear, pushing money out is not going to have any effect in the short run. But sooner or later, probably later rather than sooner, people will begin to buy other assets or consumer goods; that is, they will start to accumulate more cash balances and they will want to spend them. Traditional textbook story: Fed as helicopter drop, people wake up one morning and have more money than they want to hold, spend it. But the Fed is sprinkling it on financial institutions. When the banks are less fearful they will lend it out to consumers. We don't allow large banks to fail. Uncertainty in the markets about the policy environment. Yesterday's first speech by Treasury Secretary Timothy Geithner unveiled his plan but it didn't have many details; markets went down by 5%.
28:35Japan: Meltzer honorary adviser to Japanese Central Bank for 16 years, including all the 1990s. Governor of Bank of Japan (the Central Bank), Masaru Hayami . In Diet (parliament) they spent trillions of dollars for infrastructure, fast railroads, tracks laid down in small villages, paved every square foot. Result was nothing. Hayami believed that as long as banks aren't lending there is no point to increasing money growth, so he wouldn't do it. Successor adopted policy: buy long-term bonds. Efficient way to get money into circulation, doesn't need the banks. Fiscal stimulus failed. Monetary policy wasn't tried: Hayami didn't believe it would work. One meeting: Central bankers believed there were too many reserves in the system, something like the U.S. now. Thinking about raising interest rates; ¼ point not enough to do any harm, but it was signal that they were not going to continue a policy of providing additional money growth. Recession deepened. Mistake. Don Kohn was at the meeting also and told them in a mild way that they shouldn't do that. Can understand Hayami's unease because of lack of response of banks. What should they be doing right now? Trying to clear up the mess in the financial system.
32:21Going back to the Bear Sterns bailout/merger/marriage, Fed's and Treasury's match-making with J.P. Morgan guaranteeing $32 billion in toxic assets which at the time we were told we might break even on but now know are not worth much, March 2008: Fed and Treasury have been trying to get the banking system into health. Not very successful, prevented it from getting worse; some interest rate spreads have come down. What have they done wrong? Continued what they have been doing for 40 years: Too big to fail. That's a policy that invites people to take excessive risks. One of the main reasons we got into this mess: no bank believed they were going to fail. Greenspan put: That is, if things got bad, Greenspan would take the bad assets off their hands. Terrible policy. There are three things they can do as lender of last resort in crises like this: 1. can save the bank; 2. can merge the bank; 3. can let the bank fail. They never allowed the third option for a large bank. They need to announce that their policy is to give part of what they need at a concessional rate to any bank that needs capital, but the bank has to first raise half the capital in the marketplace. If they can't raise it in the market then the market has valued them as insolvent. We have a law on the books called the Federal Deposit Insurance Corporation Improvement Act (FDICIA), passed in 1991. While the bank still has some remaining capital, close it down, get rid of the stockholders, sell the remaining capital. What if every bank is in that situation? But they're not. Wells Fargo is not. Pittsburgh National, JP Morgan Chase doesn't have that problem. We are not going to eliminate the banks. We are going to eliminate the management and stockholders. Let the bank continue to run and sell it off, in pieces if necessary. Is that a logistical nightmare? No. People argued last March that if we let Bear Sterns go bankrupt, bankruptcy laws are so convoluted, the whole banking system would freeze up. We would just have new management. Did that for Continental Illinois back in the 1980s and sold it to Bank of America. Where will the new managers come from? They don't have to be bankers. For Continental Illinois, not a banker. Won't that be a political decision? All these decisions are political. Geithner is running into the same problem Paulson had: comes up with a program that will value the bad assets, but you can't value those bad assets at the present time. They sell every day, but their value is based on the very uncertain value of those houses and the uncertainty of the ability of anybody to put together the mortgages that have been broken apart and sold in pieces. Selling recently at $45 per $100--meaning that for a face value of $100, expect to get $45--less than half, but more than zero. But if they tried to buy all those assets at that price, they would bankrupt the banks that have to sell them. We value those banks every day; stock is sold on the market; take value for whole bank; if they can't raise the capital, they are bankrupt. Suppose a bank is holding a security on its balance sheet, mortgages or pieces of them. If none defaulted, certain cash flow. But because the default rate is uncertain--and high, house prices expected to go down 11%--discount when sold to 45 cents on the dollar. Because of mark-to-market accounting the bank is listing those assets on its books at 45 cents. Some do and some don't. The ones that do have taken their hit. But a lot say some of these mortgages we'll hold to maturity, on the hope that none of them will default, in which case they don't have to mark them to market. While the banks may do that with their accounting, the market every day values the bank, and that price values all the assets held by the bank. Big discount because of the uncertainty. If the price isn't zero, then the bank isn't insolvent by that definition. Right, but if it can't raise capital enough to comply with its reserve requirements, it's insolvent under the FDICIA law. Let the regulators take over before the entire capital is eroded so that the taxpayers wouldn't take such a big hit.
42:15What about proposals to get rid of mark-to-market accounting? Mixed mind: agree that many of these assets, the market values aren't very good; but don't like changing rules when it's convenient for you because then you don't have rules. Judges changing the value of mortgages: we have a bankruptcy law and it doesn't permit that. Bankruptcy law is valuable to have because it tells you what will happen. Not a good idea to change it. Cochrane podcast: let the system work out its problems. Paulson Treasury's answer: we asked the banks if they would do that and they said No. No surprise! Would you rather have low-cost subsidized capital or would you rather go out to the market? Of course they said they can't go out to the market, it's too hard. But there is capital out there. California bank, IndyMac, just got sold. Greenspan put: Piece in Sunday NY Times by Joe Nocera, provocative piece: investment bankers, Bear Sterns, Lehman, etc. were misperceiving the risk they were taking. Used value at risk, statistical technique for evaluating how bad things can get and risk of catastrophe. His claim: Value-at-risk tool is misleading because although it tells you the odds of a bad event, it doesn't weight the amount of the bad event. A bad event that is 1 out of 10,000 is one thing, but a bad event that destroys your company is catastrophic. Similarly, some say these banks were leveraged even 35-1, and in that situation a 4% downturn doesn't just lose you 4%, but puts you out of business. Hard to believe that managers of these firms put their companies on the line knowingly thinking that if it happens they'll be bailed out. Book: Many of these bankers had very sophisticated models of risk, using things like the normal distribution, but don't allow for large persistent one-time changes that occur. For example, the Russian default, failure of long-term capital. Instead of normal distributions, you have fat tails. Taleb's Black Swan argument, in Nocera article. But if you get a bad event every few years you'd be looking for that. You get that more frequently in recent years because no one is allowed to fail, so you get people taking big risks. SEC told investment banks they could let their leverage go up to about 30%, so they did. Managers made oodles of boodle; had risk models that didn't tell them about this event. Conversation with Myron Scholes, a principal at Long Term Capital Management (LTCM): you worked out what happens with fat tails; why didn't you tell Merriweather about that? Scholes: We did; he didn't want to hear it. One other thing: Fed did not allow them to fail. Continued to take the risks.
50:02Alternative explanation, where history comes in, explanation being pushed by some economists: Doesn't have anything to do with that, just irrational exuberance, got to dance when the music is playing. Is that plausible? Counter-evidence: JP Morgan Chase didn't do that it, Pittsburgh National didn't do it, Wells Fargo didn't do it. Bank of America didn't do it until after the crisis started it bought out Countrywide and Merrill Lynch. Did the ones that did not count on being bailed out? Yes. How would you prove that? Can't prove it. No doubt that it induces risk taking; but hard to understand how it induced so much risk taking. That goes along with the fat tails--they ignored the fat tails. Was that stupidity and myopia, or overconfidence about being bailed out? How bailed out are they? Acemoglu podcast. They've lost a lot, so ex post it was not a good strategy to count on it. But in the past they got bailed out. Look at LTCM--should have been allowed to fail. Fed just put together a consortium of private money. Leaned on private money to bail it out. Not a purely voluntary decision.
53:33How did we get into this mess--one part of it. Six reasons: will stick to two. One is: there is nothing more sacred among the sacred cows of Congress than housing. They couldn't do enough to help people buy houses, and they did what they never should have done, encouraging Fannie Mae and Freddie Mac to buy up these bad securities. Why? Fannie and Freddie subsidized interest rates. They could have subsidized them on the budget, to be transparent, what a democracy is supposed to do. But not in the interest of the Congressmen. The number of dollars they were putting out in the market went from $400 billion to $2.5 trillion since 1980, over 25 years. Question: What role did monetary policy play in this problem? Too big to fail. Second big item. John Taylor: blame Greenspan 2001-2005? Incentives. Greenspan gave them the wherewithal to buy these bad assets; but he didn't make them buy them. Claim is: in the aftermath of 9-11 attacks and Internet bubble, worry about recession, so Greenspan responds by lowering the federal funds rate to 1%, historically low level and holds it there. Did that induce liquidity in the system? Money growth wasn't all that high; we got a little inflation and Fed reacted. What he did do was encourage the subsidy: could buy a mortgage that was yielding 5-6% and finance it with short term borrowing at 1-2%. Gap between fixed and adjustable rate mortgages grew. Meltzer was visiting scholar at the Fed in 2003; Greenspan believed there was a risk of deflation and continued that policy. Tough job, make mistakes. Fifteen years good policy, made a mistake. Long term rates were falling as well. Why? They are an average of expected future short rates and they expected the Fed to continue to keep short rates low.
58:33Are you surprised at the return of John Maynard Keynes into the intellectual conversation? He was gone, other than undergraduate textbooks. Reaching for straws. No rational basis for doing what they are doing so they dream up John Maynard Keynes. Book on Keynes: Keynes used to come to the U.S. a lot during WWII, negotiating Bretton Woods. Abba Lerner, outspoken Keynesian, proposed substantial deficit spending at the end of the war, financed by bonds. Keynes went to the seminar and said "No Central Bank or government should do that." Roosevelt criticized Hoover for not balancing the budget and pushed him into balancing it by raising tax rates. WWII. 1938, Roosevelt policy advisers asked what they should do: run deficits and have a big spending program. Didn't work. Why did it work during the war? Then it was a persistent policy. Never believed that about Roosevelt previously because he kept changing his policies. Inconsistent policies. When war started, gave some certainty. Higgs podcast. Robert Barro trying to sort some of that out.

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