Ben Bernanke famously apologized to Milton Friedman saying:
Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.
Bernanke was referring to Friedman and Schwartz’ book “A Monetary History of the US”, in which they explained that the Great Depression, and the deflation that was associated with it, were a result of lousy monetary policy by the Fed. So how’s Bernanke doing on that promise? (via Supply and Demand):
Hmm, not so good Mr. Bernanke. Don’t get me wrong. This doesn’t necessarily mean we are headed for another depression and Bernanke could still avoid deflation if his monetary medicine takes hold soon. But it does beg a few questions:
- Since Bernanke has done basically what Friedman and Schwartz recommended, were they wrong?
- Is the problem today different than back then and is Bernanke using the right medecine for the wrong problem? That’s what Scwartz said in this Op-Ed in the WSJ.
- If he’s misdiagnosed the problem, will he be able to admit his mistake?
- If he does admit the mistake, how will policy change?
- If he has to change policy – again – won’t that just introduce more uncertainty, making the problem worse?
Bernanke is so focused on not repeating the mistakes of the 1930s that he’s blind to the new mistakes he’s making today. As Scwartz points out, this isn’t a liquidity problem, it’s a solvency problem. The bad banks need to be allowed to fail and that’s the one thing Bernanke won’t do. I suspect that when you apply a liquidity solution to a solvency problem the result will be inflation regardless of what the graph above says right now.