WEBVTT NOTE A Century of Failure: Why It's Time to Consider Replacing the Fed 1 00:00:00.000 --> 00:00:05.200 I'm not going to talk very much about the future, but I do want to say some things about the past. 2 00:00:05.200 --> 00:00:09.200 I want to talk about the Federal Reserve's overall record. 3 00:00:09.200 --> 00:00:14.400 And before I do so, I do want to make a kind of apology about this talk, 4 00:00:14.400 --> 00:00:23.400 because I realize that an audience like this one probably doesn't need to be convinced that the Fed is a failure. 5 00:00:23.400 --> 00:00:53.400 But nevertheless, I hope that you'll find the talk interesting because what it actually is is a talk aimed at showing that the Fed is not just a failure in our terms but a failure in its own terms and in those of the mainstream economics profession and that this is so despite the fact that your average mainstream economist continues to have a very complacent 6 00:00:53.400 --> 00:01:14.400 The Federal Reserve's attitude about the Fed, and if pressed on the subject, will insist that the Fed has, after all, and despite the recent challenges it has faced, that the Fed has been a factor that has contributed to the well-being of the American economy, and that the statistics available will show that. 7 00:01:14.400 --> 00:01:21.560 What I want to do today is to show you that that position is in fact completely unsound 8 00:01:21.560 --> 00:01:27.440 and that it is unsound in terms of the best available statistics that these very mainstream 9 00:01:27.440 --> 00:01:30.680 economists have provided us with. 10 00:01:30.680 --> 00:01:36.680 So it's a kind of imminent criticism of the Fed that I intend to give you today and it 11 00:01:36.680 --> 00:01:42.880 is a criticism once again on its own terms and on the terms of those who are its apologists. 12 00:01:42.880 --> 00:01:49.880 I don't know if we can turn down the spots a little bit on the slides. Is that possible? 13 00:01:51.200 --> 00:01:58.200 Some of these slides will require... I think that's fine. Can you see those clearly? 14 00:01:58.280 --> 00:02:02.520 I want to start by reminding you about the background of the creation of the Federal 15 00:02:02.520 --> 00:02:09.520 Reserve System. Just over 100 years ago today, 1907, we had a very terrible financial crisis, 16 00:02:09.520 --> 00:02:13.520 The Panic of 1907 17 00:02:13.520 --> 00:02:17.520 And it was approximately, at least, in response to this crisis 18 00:02:17.520 --> 00:02:21.520 that the Federal Reserve system was established. 19 00:02:21.520 --> 00:02:25.520 Now the Panic of 1907 was only one in a series of financial 20 00:02:25.520 --> 00:02:29.520 panics and crises that had beset the American economy 21 00:02:29.520 --> 00:02:33.520 in the years after the Civil War. It was also, of course, 22 00:02:33.520 --> 00:02:37.520 one of the worst. And there had been numerous attempts 23 00:02:37.520 --> 00:02:44.120 set reform of the monetary system up to the time of the panic of 1907, but that panic 24 00:02:44.120 --> 00:02:48.920 led to the establishment of something called the National Monetary Commission. 25 00:02:48.920 --> 00:02:54.120 And what the National Monetary Commission was, was a body set up to investigate both 26 00:02:54.120 --> 00:03:02.120 the nature and causes of the crises that had affected the U.S. economy up to that time, 27 00:03:02.120 --> 00:03:10.640 and alternatives to the existing monetary system with the aim of looking for a solution. 28 00:03:10.640 --> 00:03:14.480 Now I have to say it was a loaded commission. 29 00:03:14.480 --> 00:03:19.880 By the time this commission was set up it was very clear that the intentions of the 30 00:03:19.880 --> 00:03:24.400 people behind it, especially Nelson Aldrich who was behind the passage of the bill in 31 00:03:24.400 --> 00:03:31.460 question was that there should be an outcome favoring the establishment of a central bank. 32 00:03:31.460 --> 00:03:41.920 But what I want to convince you of is that today there is no less need to consider alternatives 33 00:03:41.920 --> 00:03:46.380 to the Fed than there was then and indeed the statistics suggest that we should be less 34 00:03:46.380 --> 00:03:51.620 happy with our monetary system now than people were in 1907. 35 00:03:51.620 --> 00:03:56.500 And we need something like a National Monetary Commission, though hopefully one that will 36 00:03:56.500 --> 00:04:03.660 will really try to establish an improved system. 37 00:04:03.660 --> 00:04:08.940 The outcome of the National Monetary System was, of course, not that disaster, but this 38 00:04:08.940 --> 00:04:12.420 one, the establishment of the Federal Reserve System. 39 00:04:12.420 --> 00:04:18.140 And it's that system, of course, that was supposed to provide for much greater stability 40 00:04:18.140 --> 00:04:24.660 and a much improved monetary arrangement than that which preceded it, than the national 41 00:04:24.660 --> 00:04:39.420 Here are some elements of the Fed's mission, as stated in its own publications or in the 42 00:04:39.420 --> 00:04:45.460 Federal Reserve Act itself, and they include, as you can see, promoting effectively the 43 00:04:45.460 --> 00:04:51.820 The Goals of Maximum Employment, Stable Prices, Moderate Long-Term Interest, and Moderate 44 00:04:51.820 --> 00:04:53.580 Long-Term Interest Rates. 45 00:04:53.580 --> 00:04:59.380 Elsewhere, the Fed says that it's responsible for containing financial disruptions and preventing 46 00:04:59.380 --> 00:05:02.660 their spread outside the financial sector. 47 00:05:02.660 --> 00:05:10.660 So these suggest, these goals, these official goals of the Fed suggest criteria by which 48 00:05:10.660 --> 00:05:17.660 which we should evaluate the system's success, and that's what I intend to do. 49 00:05:18.580 --> 00:05:24.140 I'm not going to say a whole lot about employment and unemployment, for the simple reason that 50 00:05:24.140 --> 00:05:31.140 as you all know, the factors that are responsible for the unemployment rate are, well, quite 51 00:05:31.740 --> 00:05:38.740 numerous. And the role of monetary policy in influencing unemployment is certainly important, 52 00:05:38.740 --> 00:05:55.740 are certainly important, but it's hard to separate the influence of monetary developments from other developments. Nevertheless, for what it's worth, we can ask, has the Federal Reserve era brought us an improved lower rate of employment than we saw before? 53 00:05:55.740 --> 00:05:58.740 And here's what the available statistics show. 54 00:05:58.740 --> 00:06:06.740 What I've done on these charts, I've tried to supply a vertical line indicating where the Fed was founded 55 00:06:06.740 --> 00:06:13.740 and other vertical lines to show significant cutoffs from other regime changes. 56 00:06:13.740 --> 00:06:18.740 Most economists are very keen that we should separate the interwar years, that is, 57 00:06:18.740 --> 00:06:24.740 those between the establishment of the Fed and the end of World War II, from other years. 58 00:06:24.740 --> 00:06:34.740 That is, they like to treat the interwar period, the first decades of the Fed, as if it was practice, right? 59 00:06:34.740 --> 00:06:43.740 And you can understand why, especially if the goal is to apologize for the Fed, because everyone admits the interwar period was a lousy period, 60 00:06:43.740 --> 00:06:48.740 it was the worst period in the performance of the U.S. economy. Let's hope it stays the worst period. 61 00:06:48.740 --> 00:06:52.260 That certainly is true with respect to unemployment. 62 00:06:52.260 --> 00:06:59.100 You can see the average rate of unemployment mainly thanks to the Great Depression is much higher than in any other period. 63 00:06:59.100 --> 00:07:13.980 But even if we focus on the post-war period, well, we find a slight improvement in the period between the end of World War II and the final abandonment of the gold standard or closing of the gold window in 1971. 64 00:07:13.980 --> 00:07:21.980 But since then the unemployment rate has actually averaged a much higher level and of course the recent developments are only going to make it worse. 65 00:07:21.980 --> 00:07:32.980 Now we've got changes in unionization, minimum wage laws, a million other factors happening apart from monetary policy, which is why I don't want to put too much emphasis on this. 66 00:07:32.980 --> 00:07:46.980 But at least a bare comparison of the statistical record shows that we can't say that the post-Federal Reserve era has somehow ushered in a period of much lower average unemployment than before. 67 00:07:46.980 --> 00:08:00.980 And indeed, again, that's true if you just look at post-World War II, if you throw in the interwar practice years, the Fed's promise has been even more glaringly broken. 68 00:08:00.980 --> 00:08:19.980 I do think we should pay a lot more attention to the question of price stability, the behavior of prices, because everyone understands that the behavior of the price level and the inflation rate, that is something that the Federal Reserve can be held responsible for almost exclusively. 69 00:08:19.980 --> 00:08:35.980 Here we have a nice quote from Bernanke telling us about the importance of stable prices and how they allow the dollar to serve as a measure of value in making long-term contracts, engaging in long-term planning, or borrowing and lending for long periods. 70 00:08:35.980 --> 00:08:40.980 So, given that this is very important, how good a job has the Fed done? 71 00:08:40.980 --> 00:08:50.980 Well, it's notorious to all of you, of course, and to most people, that with respect to preserving the purchasing power of money, the record of the Fed has been appalling. 72 00:08:50.980 --> 00:09:00.980 Here you see statistics for the CPI, and I didn't draw a vertical line here, but the creation of the Fed would be around there. 73 00:09:00.980 --> 00:09:07.680 What's interesting is, if you look at the CPI, between 1790 and the Fed's establishment, 74 00:09:07.680 --> 00:09:12.580 the difference in the price indices is about 8%. 75 00:09:12.580 --> 00:09:21.020 The price index is about 100 in 1790, then the index would be 108 or so in 1914. 76 00:09:21.020 --> 00:09:23.620 A very trivial difference. 77 00:09:23.620 --> 00:09:29.540 Now those statistics are very, very crude and rough, but they're as good as anyone has 78 00:09:29.540 --> 00:09:30.540 come up with. 79 00:09:30.540 --> 00:09:36.780 or alternative measures we could point to, but they all tell essentially the same story. 80 00:09:36.780 --> 00:09:41.340 Almost from the beginning of the Fed's establishment, and a later slide will make it clear, the 81 00:09:41.340 --> 00:09:49.580 value of the dollar has inexorably gone down, with the notable exceptions of severe deflations 82 00:09:49.580 --> 00:09:53.220 in the Great Depression or interwar period. 83 00:09:53.220 --> 00:09:55.280 Let's look a little more closely. 84 00:09:55.280 --> 00:09:59.980 This is what's happened to the value of the dollar since the Fed's establishment. 85 00:09:59.980 --> 00:10:04.060 So this is the purchasing power of the dollar rather than the price level so it obviously 86 00:10:04.060 --> 00:10:06.600 goes in the opposite direction. 87 00:10:06.600 --> 00:10:12.060 And one of the things that's worth noting is that the greatest decline in the dollar 88 00:10:12.060 --> 00:10:17.700 has happened or the greatest declines have tended to coincide with periods when the Federal 89 00:10:17.700 --> 00:10:23.800 Reserve had the restraints imposed on it by the gold standard relaxed. 90 00:10:23.800 --> 00:10:26.880 This next slide will show it more clearly still. 91 00:10:26.880 --> 00:10:37.840 Here you have monthly inflation. What many people are unaware of is that the worst inflation 92 00:10:37.840 --> 00:10:44.120 episode in the post-Civil War period in the United States was not the one in the 1970s 93 00:10:44.120 --> 00:10:50.000 and early 1980s. It was actually one that took place immediately after the Fed's establishment 94 00:10:50.000 --> 00:10:56.520 during World War I, where monthly rates, some of them, of quarterly rates of inflation, 95 00:10:56.520 --> 00:11:04.320 if you annualize them, for some quarters were as high as 40%, equivalent to a 40% annual 96 00:11:04.320 --> 00:11:08.920 rate of inflation, which is several times higher than the highest annualized inflation 97 00:11:08.920 --> 00:11:14.440 rates of the 70s. Now what's going on there, I'm referring to the inflation over here, 98 00:11:14.440 --> 00:11:19.960 what's going on there is that there's an embargo on gold exports. We didn't go off the gold 99 00:11:19.960 --> 00:11:25.520 The gold standard, but the restraints on Federal Reserve money creation were relaxed considerably 100 00:11:25.520 --> 00:11:31.880 compared to the rest of the period prior to the Great Depression. 101 00:11:31.880 --> 00:11:34.300 The same thing happens in the 70s. 102 00:11:34.300 --> 00:11:40.440 You get high inflation following the abandonment of the gold standard. 103 00:11:40.440 --> 00:11:46.200 Here you have also some inflation in connection with the Second World War. 104 00:11:46.200 --> 00:11:52.480 The basic story is the more you relax the constraints on the Fed imposed by the existence 105 00:11:52.480 --> 00:11:56.820 of some kind of gold standard, the more it takes advantage of it to contribute to the 106 00:11:56.820 --> 00:11:59.480 erosion of the purchasing power of money. 107 00:11:59.480 --> 00:12:04.840 Putting it the other way, to the extent that the Fed has in some parts of its existence 108 00:12:04.840 --> 00:12:13.040 resisted allowing the value of money to decline, it has done so mostly while it has been constrained 109 00:12:13.040 --> 00:12:14.440 by the gold standard. 110 00:12:14.440 --> 00:12:23.440 The gold standard research tank for what little preservation of the purchasing power of money has taken place since the Fed's establishment, not the Fed itself. 111 00:12:27.440 --> 00:12:36.440 Bernanke's statement emphasizes long-term contracting and the need for people to be able to predict what's happening to the price level. 112 00:12:36.440 --> 00:12:42.440 How good a job is the Fed done with regard to the predictability of prices? 113 00:12:42.440 --> 00:12:54.440 It's important to see that the high inflation or rapidly eroding purchasing power of money doesn't necessarily mean a more difficult to predict inflation rate or purchasing power of money, right? 114 00:12:54.440 --> 00:13:05.440 And some economists have argued that, well, even though the inflation rate has tended to get worse since the Fed's establishment, inflation and the price level have become more predictable, right? 115 00:13:05.440 --> 00:13:17.440 The inflation rate tends to be high but you know where it's going to be whereas before the Civil War it was harder to predict the rate of inflation. 116 00:13:17.440 --> 00:13:29.440 There's some truth to that but the truth to it is such as really doesn't mean that it was easier to make long-term contracts before the Fed's establishment, quite the contrary. 117 00:13:29.440 --> 00:13:35.440 Under the pre-fed gold standard, as we've seen, the price level in the long run didn't change much at all. 118 00:13:35.440 --> 00:13:44.440 Well, that implied that if you did have some increase in the price level, chances were you were going to have some downward movement to offset that in the future. 119 00:13:44.440 --> 00:13:47.440 And that's exactly what happened in the gold standard period. 120 00:13:47.440 --> 00:13:54.440 So you couldn't predict, it wasn't a good guess that the inflation rate tomorrow would be like the inflation rate yesterday. 121 00:13:54.440 --> 00:13:57.440 It might well be negative, the inflation rate yesterday. 122 00:13:57.440 --> 00:14:03.440 But in terms of predictability of the long run price level, that isn't the right question to ask. 123 00:14:03.440 --> 00:14:15.440 The right question to ask is how much uncertainty is likely to be connected with your guess of the price level five years from now, ten years from now, a hundred years from now, right? 124 00:14:15.440 --> 00:14:22.440 How accurate will our forecast be for those long horizons if we're trying to say make investments for those periods? 125 00:14:22.440 --> 00:14:37.440 What this chart shows, I won't go into the boring statistical details, but this shows, as it were, a measure of the price level uncertainty for different forecast periods or horizons. 126 00:14:37.440 --> 00:14:51.440 First under the pre-fed, pre-1914 period, and the data here start in the 1870s, and then we looked at the uncertainty for a five-year horizon, a 30-year planning horizon, 127 00:14:51.440 --> 00:14:54.560 and then a 100-year horizon. 128 00:14:54.560 --> 00:14:57.880 And over here, we look with the same scales 129 00:14:57.880 --> 00:15:00.920 at the levels of uncertainty 130 00:15:00.920 --> 00:15:03.240 during the post-World War II period. 131 00:15:03.240 --> 00:15:06.080 We're leaving the interwar period out again 132 00:15:06.080 --> 00:15:10.760 to give the Fed as much credibility as possible. 133 00:15:10.760 --> 00:15:15.760 And as you can see, the further you go out in time, 134 00:15:16.600 --> 00:15:18.440 the more, I don't know what's happened to my, 135 00:15:18.440 --> 00:15:19.400 oh, I've covered it. 136 00:15:19.400 --> 00:15:25.560 The more your predictability declines, what does this mean in practice? 137 00:15:25.560 --> 00:15:32.080 It meant that, whereas during the gold standard pre-fed period, especially in the last part 138 00:15:32.080 --> 00:15:37.380 of the 19th century, all kinds of companies, railroad companies and other companies were 139 00:15:37.380 --> 00:15:42.480 issuing 100-year bonds, right? 140 00:15:42.480 --> 00:15:46.440 Because there was enough predictability out there, there was enough certainty, of course 141 00:15:46.440 --> 00:15:54.640 There was enough certainty based on past experience that people felt confident that they knew what 142 00:15:54.640 --> 00:16:01.280 the price level was going to be in 100 years, confident enough to issue 100 year bonds. 143 00:16:01.280 --> 00:16:06.160 This picture, if you believe it, would lead you to conclude that the market for such long-term 144 00:16:06.160 --> 00:16:07.760 bonds would completely dry up. 145 00:16:07.760 --> 00:16:15.680 In fact, it did, completely dried up until the 1990s when a period called the Great Moderation 146 00:16:15.680 --> 00:16:21.580 of Relative Stability somewhat revived the market for such long-term securities. Nevertheless, 147 00:16:21.580 --> 00:16:28.580 the overall record of the Fed has been not to make it easier for people to invest or 148 00:16:28.580 --> 00:16:35.040 to keep interest rates low for long-term investments, but just the opposite. By the way, the current 149 00:16:35.040 --> 00:16:41.820 situation surely is one where what little revival in long-term lending markets had taken 150 00:16:41.820 --> 00:16:47.380 in place in the 90s. I'm sure that that is just about drying up again. If anybody's issuing 151 00:16:47.380 --> 00:16:54.980 100-year bonds right now, well, I want to know because I might want to buy some. Now, 152 00:16:54.980 --> 00:16:59.660 some people will tell you, a lot of economists will tell you that, well, even though the 153 00:16:59.660 --> 00:17:05.140 Fed's allowed persistent inflation for most of its existence, at least it's prevented 154 00:17:05.140 --> 00:17:10.020 deflation most of the time. And that's good because deflation is really, really bad. And 155 00:17:10.020 --> 00:17:15.800 The gold standard, in contrast, and the pre-fed arrangement that went with the gold standard, 156 00:17:15.800 --> 00:17:20.680 that allowed a lot of deflation, and therefore, even though the feds allowed inflation, it 157 00:17:20.680 --> 00:17:25.020 has made up for that by preventing deflation, which is even worse. 158 00:17:25.020 --> 00:17:30.340 Well, to confront this argument, if the first of all recognize what a lot of economists 159 00:17:30.340 --> 00:17:35.580 don't recognize, but good ones, and not just Austrians, but good mainstream ones do, there 160 00:17:35.580 --> 00:17:41.740 There are two kinds of deflation, good and bad. Good deflation, well bad deflation is 161 00:17:41.740 --> 00:17:47.940 this kind. Here you've got the supply of goods, you've got the prices and output. If there's 162 00:17:47.940 --> 00:17:55.300 a decline in the money supply, for example, a sudden shrinkage, the demand schedule collapses, 163 00:17:55.300 --> 00:18:01.100 or a financial crisis like we had in 2008, you will get a fall in prices and that fall 164 00:18:01.100 --> 00:18:06.140 People and prices will be associated with reduced output and unemployment, the classic 165 00:18:06.140 --> 00:18:11.380 deflationary crisis. The Great Depression, the beginnings of the Depression in the early 166 00:18:11.380 --> 00:18:16.220 30s fit this pattern. It's the kind of deflation Bernanke worries about, but he also tends 167 00:18:16.220 --> 00:18:20.780 to assume it's the only kind. Let's just accept that this is bad. And by the way, if 168 00:18:20.780 --> 00:18:25.420 you do, remember it's not the deflation that's bad. The deflation is the economy's way of 169 00:18:25.420 --> 00:18:29.100 dealing with a collapse of output. If there were more deflation, you'd actually be better 170 00:18:59.100 --> 00:19:05.100 The downward movement prices is associated with improvements in output, increased output. 171 00:19:05.100 --> 00:19:09.100 What about the Fed's record with respect to deflation? 172 00:19:09.100 --> 00:19:16.100 The deflation that took place in the pre-Fed period, with short exceptions, was mostly benign deflation. 173 00:19:16.100 --> 00:19:20.100 It was mostly driven by improvements in supply. 174 00:19:20.100 --> 00:19:22.100 So mostly good deflation. 175 00:19:22.100 --> 00:19:27.100 After the Fed's establishment, good deflation pretty much disappeared. 176 00:19:27.100 --> 00:19:40.100 There's hardly any episode where the Fed allowed prices to fall in response to improved output, even though output did improve for much of the Fed period. The Fed offset that with money creation. 177 00:19:40.100 --> 00:19:56.100 But that bad deflation actually became, if not more common, it became worse. That is, there were a few episodes of bad deflation that were the worst episodes ever under the Fed's term. 178 00:19:56.100 --> 00:20:04.500 The most notorious of the early 1930s, another one before that in 1920-21, recently a very 179 00:20:04.500 --> 00:20:08.540 bad episode of bad deflation in early 2008. 180 00:20:08.540 --> 00:20:12.700 So what the Fed's done is it wiped out the good kind of deflation, it gave us the worst 181 00:20:12.700 --> 00:20:18.740 ever episodes of bad deflation, and then whenever it wasn't doing that it gave us bad inflation. 182 00:20:18.740 --> 00:20:23.460 So overall the record on the price level, and again this is in terms that any mainstream 183 00:20:23.460 --> 00:20:29.460 that any economist should be able to accept has been very bad. 184 00:20:29.460 --> 00:20:34.460 Speaking of the mainstream, here's an article that appeared in the American Economic Review, a conclusion of it lately. 185 00:20:34.460 --> 00:20:40.460 It says, a broad historical look finds many more periods of deflation with reasonable growth than with depression, 186 00:20:40.460 --> 00:20:44.460 and many more periods of depression with inflation than with deflation. 187 00:20:44.460 --> 00:20:49.460 And what are the exceptions? Well, they're all after the Fed's establishment. 188 00:20:49.460 --> 00:21:11.460 Here is the bad deflation of the early 30s, here is the recent one, you can see the percent change in CPI and what's happening with output at the same time. 189 00:21:11.460 --> 00:21:23.460 All right. Let's talk about stability of output. One of the other prominent goals of the Fed and supposed accomplishments of the Fed is to stabilize the economy. 190 00:21:23.460 --> 00:21:31.460 Now we're just going to look at plain old statistics of the variability of output. Couldn't be cruder about this, but this is how most economists think about it. 191 00:21:31.460 --> 00:21:37.460 Look at what's happening in the standard deviation of output. Is it better before the Fed or after? 192 00:21:37.460 --> 00:21:42.460 Most economists, until recently, would have said, well, the Fed has improved things. 193 00:21:42.460 --> 00:21:46.460 Well, okay, not between the wars. That was practice. 194 00:21:46.460 --> 00:21:52.460 But since World War II, output has been more stable than before the Fed was created. 195 00:21:52.460 --> 00:22:00.460 And indeed, the early statistics, the statistics that everybody relied on until about 20 years ago, do suggest that. 196 00:22:00.460 --> 00:22:04.460 So here's, this shows you, I'm sorry, I didn't write those vertical lines. 197 00:22:04.460 --> 00:22:12.460 Here's the Fed's establishment. Here's that nasty interwar period. We leave that out, which is a big concession, isn't it? 198 00:22:12.460 --> 00:22:20.460 We leave that out, practice, and we look at the standard deviation here and compare it to over here. This is smoother. 199 00:22:20.460 --> 00:22:29.460 Except, those pre-war output statistics, turns out that they are deeply flawed. 200 00:22:29.460 --> 00:22:33.460 and we know that they are deeply flawed thanks to this person. 201 00:22:33.460 --> 00:22:37.460 That's Christina Romer and she was until last August 202 00:22:37.460 --> 00:22:42.460 the head of the President's Council of Economic Advisers. 203 00:22:42.460 --> 00:22:47.460 Romer did some close examination of the old statistics used 204 00:22:47.460 --> 00:22:52.460 for output in the United States in the days before 1920 actually 205 00:22:52.460 --> 00:22:56.460 and she realized that what people had done was they had used 206 00:22:56.460 --> 00:23:00.780 commodity prices because they didn't have prices for a lot of other kinds of output 207 00:23:00.780 --> 00:23:05.420 and then they assume that all prices kind of fluctuated as much as commodity prices. 208 00:23:05.420 --> 00:23:11.740 Well, she noted, if you look at commodity prices and other prices since the Fed's establishment, 209 00:23:11.740 --> 00:23:17.260 when we have good statistics on both, commodity prices are much more volatile than other prices, 210 00:23:17.260 --> 00:23:26.140 about five times as much. So these old statistics would have grossly exaggerated 211 00:23:26.140 --> 00:23:31.140 the volatility of the output measures, right? 212 00:23:32.260 --> 00:23:34.660 So she goes back and she comes up 213 00:23:34.660 --> 00:23:37.700 with her own statistics modified for the difference 214 00:23:37.700 --> 00:23:40.220 between how much commodity output fluctuates 215 00:23:40.220 --> 00:23:43.660 and commodity prices compared to other kinds. 216 00:23:43.660 --> 00:23:47.860 And this is what her standard deviation measures look like. 217 00:23:47.860 --> 00:23:49.900 And they make a huge difference, 218 00:23:49.900 --> 00:23:50.900 because it turns out now, 219 00:23:50.900 --> 00:23:53.720 if you look at the average variability of output 220 00:23:53.720 --> 00:23:57.200 before the Fed and after, it's about the same. 221 00:23:58.080 --> 00:24:01.720 And in fact, depending on how you take the trend out, 222 00:24:01.720 --> 00:24:03.900 because you have to take the trend out, right, 223 00:24:03.900 --> 00:24:06.300 to come up with a standard deviation, 224 00:24:06.300 --> 00:24:09.420 if you do it in a somewhat, in what most economists consider 225 00:24:09.420 --> 00:24:13.060 a more sophisticated way that allows for a varying trend 226 00:24:13.060 --> 00:24:17.060 instead of just a linear one, a terministic trend, 227 00:24:17.060 --> 00:24:20.460 the pre-war period looks more stable, 228 00:24:20.460 --> 00:24:22.300 the pre-Fed period looks more stable 229 00:24:22.300 --> 00:24:27.940 from the post-World War II period. More stable than the post-World War II period. Throw the 230 00:24:27.940 --> 00:24:35.620 interwar period in and the Fed's overall record in terms of sheer stability of output is much 231 00:24:35.620 --> 00:24:43.660 worse than the pre-fed period. Now, notice the pre-fed system stank. It was a lousy system. 232 00:24:43.660 --> 00:24:47.900 So when I'm saying these things, I'm not saying to you, oh, we should go back to the pre-fed 233 00:24:47.900 --> 00:24:53.700 System. What I am saying is, the Fed cannot claim that it has accomplished, even since 234 00:24:53.700 --> 00:25:03.700 World War II, more stability than the old system. Now, you would be right if you said 235 00:25:03.700 --> 00:25:09.500 to me, and a lot of economists would make this point, of course, say, well, look, you 236 00:25:09.500 --> 00:25:14.340 know, a lot of things have changed since 1914, besides the fact that we now have a Fed, but 237 00:25:14.340 --> 00:25:20.460 You can't just look at these statistics you've been looking at, for example, about the fluctuations 238 00:25:20.460 --> 00:25:27.440 in output and say, well, the differences are only because before you had no FED and now 239 00:25:27.440 --> 00:25:31.940 you do. Absolutely. There are a lot of other changes that have taken place in the structure 240 00:25:31.940 --> 00:25:37.820 of the economy. However, looking at most of these changes, what you find is, well, looking 241 00:25:37.820 --> 00:25:43.020 at as many as I can think of, what you find is most of the changes either shouldn't have 242 00:25:43.020 --> 00:25:50.020 There is one major structural change that I can think of, that certainly would have made a difference, apart from what the Monetary Regulatory Commission has done in the last couple of years. 243 00:25:50.020 --> 00:25:55.020 It has made a difference in the kinds of output fluctuations that we've just been looking at. 244 00:25:55.020 --> 00:25:58.020 That is, there's no reason to think their effects would be neutral. 245 00:25:58.020 --> 00:26:01.020 Example, we have a lot less agriculture. 246 00:26:01.020 --> 00:26:03.020 We've got a lot more services. 247 00:26:03.020 --> 00:26:05.020 Manufacturing actually hasn't changed that much. 248 00:26:05.020 --> 00:26:12.020 So those shares have changed, but there's no reason to think that that shift would have made much difference in overall output stability. 249 00:26:12.020 --> 00:26:14.340 from what the monetary regime was. 250 00:26:14.340 --> 00:26:16.940 And that is the size of government. 251 00:26:16.940 --> 00:26:18.700 Mainstream economists will tell you 252 00:26:18.700 --> 00:26:21.340 that because government hands out welfare payments 253 00:26:21.340 --> 00:26:24.780 and other things that are either acyclical, 254 00:26:24.780 --> 00:26:28.580 those payments don't decline when output generally declines, 255 00:26:28.580 --> 00:26:30.020 or they're counter-cyclical, 256 00:26:30.020 --> 00:26:32.540 they actually go up when output declines, 257 00:26:32.540 --> 00:26:35.140 that the bigger government gets relative 258 00:26:35.140 --> 00:26:38.000 to the whole economy, the more stability you should have 259 00:26:38.000 --> 00:26:41.580 in total measured GDP, right? 260 00:26:41.580 --> 00:26:44.940 They don't necessarily say, therefore you should have big government, some of them do, 261 00:26:44.940 --> 00:26:48.260 because it also is true that you get less total output as government grows, 262 00:26:48.260 --> 00:26:52.460 according to the statistical studies that show the stabilizing effect of more government. 263 00:26:52.460 --> 00:26:56.940 In any event, government's grown tremendously since the Fed was established. 264 00:26:56.940 --> 00:27:02.100 It's not counting the recent burst of government growth. 265 00:27:02.100 --> 00:27:07.220 It's about five, there's about five times as much government spending as a share of GDP today, 266 00:27:07.220 --> 00:27:13.940 or say in early 2008 than there was in 1914, which according to some studies should have 267 00:27:13.940 --> 00:27:19.540 meant a tremendous improvement in macroeconomic stability, that is, stability of output. 268 00:27:19.540 --> 00:27:25.340 So if you controlled for that, you should have expected the Fed, we should expect the 269 00:27:25.340 --> 00:27:33.060 post-Fed era, even if the Fed had done nothing to change stability, to show a lot less instability 270 00:27:33.060 --> 00:27:38.740 and the pre-fed era. Yet it is about the same if not slightly worse in the post-fed period. 271 00:27:38.740 --> 00:27:45.740 So something is offsetting the tendency of big government to stabilize GDP. And it's 272 00:27:45.740 --> 00:27:57.740 obviously, one possible candidate is the Fed. The Fed's actually been destabilizing a lot. 273 00:27:57.740 --> 00:28:05.900 Another thing that we can look at is the frequency and length of business recessions or contractions. 274 00:28:05.900 --> 00:28:11.800 Now, for better or worse, the official body that has always decided when these are taking 275 00:28:11.800 --> 00:28:17.220 place and how long they last is the National Bureau of Economic Research. 276 00:28:17.220 --> 00:28:22.580 And of course, they're the ones who assure us that the most recent recession ended June 277 00:28:22.580 --> 00:28:24.380 of 2009. 278 00:28:24.380 --> 00:28:42.380 According to the same people, the frequency and length of recessions before 1914, there were many more recessions and they lasted a lot longer before 1914 than since World War II. 279 00:28:42.380 --> 00:28:48.380 We leave out the interwar period because that was practice. 280 00:28:48.380 --> 00:28:58.380 Right. So, now, the way in which the NBER dates cycles is quite mysterious, and I think it might be mysterious even for the people in the NBER. 281 00:28:58.380 --> 00:29:08.380 And it's mysterious the way they do it for recent cycles. The further back you go in history, though, the more bizarre their dating methods become, 282 00:29:08.380 --> 00:29:13.980 The point where, once again, Christina Romer, who's done a lot of research on this, had 283 00:29:13.980 --> 00:29:19.780 went back and determined that actually their dating of pre-fed business cycles was completely 284 00:29:19.780 --> 00:29:26.780 bogus. So she did some re-dating and she came up with this conclusion, based on her own 285 00:29:27.440 --> 00:29:34.440 more careful statistics. And this is Christina Romer. This is not, she is not a Mises fellow. 286 00:29:34.440 --> 00:29:41.440 This is in 1999, this quote. That's very significant, right? 287 00:29:41.440 --> 00:29:46.440 Recessions have not become noticeably shorter over time. 288 00:29:46.440 --> 00:29:55.440 The average length of recessions is actually one month longer in the post-World War II era than in the pre-World War I era. 289 00:29:55.440 --> 00:30:02.440 There's also no obvious change in distribution of the length of recessions between the pre-war and post-war eras. 290 00:30:02.440 --> 00:30:12.440 Christina Romer, 1999. Why am I stressing that? Obviously because if you add recent experience, that conclusion is going to get stronger, isn't it? 291 00:30:16.440 --> 00:30:30.440 Just to give you an idea of how much difference it makes when you recalculate these statistics, another economist went a little further back at Romer and looked at, among other things, at the crisis of 1873. 292 00:30:30.440 --> 00:30:38.440 According to the NBER, that thing lasted for six years. It was a recession that lasted from 1873 to 1879. 293 00:30:38.440 --> 00:30:44.440 The longest in history? Well, according to the revised statistics, it lasted two years. 294 00:30:44.440 --> 00:30:49.440 A little longer than the official duration of the most recent recession. 295 00:30:49.440 --> 00:30:55.440 So, obviously, a lot depends on which statistics you're using. 296 00:30:55.440 --> 00:31:12.440 One more factor worth considering. When we talk about the fluctuations in the economy, we should really consider what the sources of those fluctuations are. 297 00:31:12.440 --> 00:31:18.440 Economies can be exposed to either shocks to supply or shocks to demand. 298 00:31:18.440 --> 00:31:25.160 Now, we expect the monetary system to minimize the latter. Shocks to demand, shocks to spending. 299 00:31:25.160 --> 00:31:30.520 A well-functioning monetary system will tend to stabilize those. If the demand for money 300 00:31:30.520 --> 00:31:35.360 goes up, the supply can go up somewhat and keep spending on an even keel. This is, by 301 00:31:35.360 --> 00:31:39.440 the way, the standard view. If you have a Misesian alternative view, that's fine, but 302 00:31:39.440 --> 00:31:45.920 we're making an imminent criticism. On the other hand, supply shocks can happen that 303 00:31:45.920 --> 00:31:49.320 Monetary authorities are powerless to do anything about. 304 00:31:49.320 --> 00:31:52.840 For example, bad harvests or a war. 305 00:31:52.840 --> 00:31:55.960 Well, we should therefore try to take account 306 00:31:55.960 --> 00:31:58.760 of the different incidents of supply and demand shocks 307 00:31:58.760 --> 00:32:01.560 in the pre and post-Fed period to get a true grasp 308 00:32:01.560 --> 00:32:03.880 of how much the Fed has contributed 309 00:32:03.880 --> 00:32:06.080 or detracted from stability. 310 00:32:06.080 --> 00:32:09.600 Well, if you do, statistically, you come up with this. 311 00:32:09.600 --> 00:32:12.440 In the pre-Fed period, supply shocks 312 00:32:12.440 --> 00:32:16.300 were overwhelmingly responsible for fluctuations in output. 313 00:32:16.300 --> 00:32:19.760 They explain something like 90% of those fluctuations. 314 00:32:19.760 --> 00:32:24.820 In the post-fed period, depending on which horizon you look at, 315 00:32:24.820 --> 00:32:27.860 they explain a much smaller percent. 316 00:32:27.860 --> 00:32:31.160 In other words, the pre-fed period was one where 317 00:32:31.160 --> 00:32:34.640 the monetary system could not be expected 318 00:32:34.640 --> 00:32:36.520 to produce much more stable output 319 00:32:36.520 --> 00:32:39.820 because there were big supply innovations 320 00:32:39.820 --> 00:32:42.000 and harvest failures and other things 321 00:32:42.000 --> 00:32:44.360 that were quite independent of the performance 322 00:32:44.360 --> 00:32:46.720 of the monetary system that were causing output 323 00:32:46.720 --> 00:32:48.400 to bounce around back then. 324 00:32:48.400 --> 00:32:52.200 Since the war, those fluctuations have been 325 00:32:52.200 --> 00:32:54.000 relatively much less important. 326 00:32:54.000 --> 00:32:57.640 So once again, the bare statistics exaggerate 327 00:32:57.640 --> 00:32:59.760 the success of the Fed. 328 00:32:59.760 --> 00:33:02.440 And if we have to adjust, we need to adjust downward 329 00:33:02.440 --> 00:33:04.500 our assessment of the Fed's performance, 330 00:33:04.500 --> 00:33:07.140 its contribution to economic stability. 331 00:33:10.160 --> 00:33:11.680 Banking panics. 332 00:33:11.680 --> 00:33:18.000 Well, a lot of people feel that the Fed as a central bank capable of acting as a lender 333 00:33:18.000 --> 00:33:22.620 of last resort has helped at least to minimize banking panics. 334 00:33:22.620 --> 00:33:27.040 You don't need to be told in this room that the very worst banking panic of all, that 335 00:33:27.040 --> 00:33:33.400 of the early 1930s, took place during the Fed era. 336 00:33:33.400 --> 00:33:38.560 It was much worse than the one in 1907 that prompted the creation of the Fed in the first 337 00:33:38.560 --> 00:33:46.560 Here, though, is an overall assessment of the record of the Fed with respect to the pre-Fed era with regard to banking panics. 338 00:33:46.560 --> 00:33:49.560 Elmer Swicker knows more about this than anyone else. 339 00:33:49.560 --> 00:33:57.560 And as you can see, he concludes that there were no more than three major banking panics between 1873 and 1907, 340 00:33:57.560 --> 00:34:05.560 two incipient panics in 1884 and 1890, twelve major panics between 1873 and 1907, 341 00:34:05.560 --> 00:34:21.560 Panics in 1884 and 1890, 12 years elapsed between the Panic of 1861 and that of 1873 and 20 years between the Panics of 1873 and 1893 and 14 between the Panics of 1893 and 1907. 342 00:34:21.560 --> 00:34:30.560 Three banking panics in half a century and only one of three, 1893, did the number of bank suspensions match those of the Great Depression. 343 00:34:30.560 --> 00:34:36.560 During the early thirties, Wicker also writes elsewhere, there were five major panics in a row. 344 00:34:39.560 --> 00:34:46.560 Now, panics did stop, but they stopped after the holiday of March 1933. 345 00:34:46.560 --> 00:34:50.560 This figure shows the total number of bank suspensions. 346 00:34:50.560 --> 00:34:56.560 As you can see, they actually go up in the early years of the Fed, and then they stop almost altogether. 347 00:34:56.560 --> 00:35:02.560 The bank suspensions here are a rough measure of bank panics. When you have enough of them, it's a panic. How's that? 348 00:35:02.560 --> 00:35:06.560 They do stop after 1933, but what's behind that? 349 00:35:06.560 --> 00:35:14.560 Not the Fed. When the Fed existed but the FDIC didn't, bank failures are getting worse and worse. 350 00:35:14.560 --> 00:35:21.560 It's the FDIC, deposit insurance, that for a while is putting a lid on major bank suspensions. 351 00:35:21.560 --> 00:35:27.200 and we know why it did that it allowed the banks essentially to be guaranteed 352 00:35:27.200 --> 00:35:34.620 at the risk of the exposing taxpayers ultimately of course that system would 353 00:35:34.620 --> 00:35:39.240 itself come unglued so I'm not recommending FDIC I'm pointing out to 354 00:35:39.240 --> 00:35:43.800 you though that the statistics clearly show that it wasn't until the advent of 355 00:35:43.800 --> 00:35:48.400 the FDIC that bank panics and suspensions at least for a time went 356 00:35:48.400 --> 00:35:56.600 away, the Fed itself did nothing to prevent the incidence of panics. 357 00:35:56.600 --> 00:36:01.600 Here you can see that the good news didn't, that the success of the FDIC doesn't go on 358 00:36:01.600 --> 00:36:07.120 into the recent era. 359 00:36:07.120 --> 00:36:09.320 What about the recent crisis itself? 360 00:36:09.320 --> 00:36:15.080 Well, Bill Buder, who's a very good economist, again not a Mises Institute type at all, concludes 361 00:36:15.080 --> 00:36:20.080 is that the interventions during this crisis, far from having contributed overall to the 362 00:36:20.080 --> 00:36:27.560 stability of the U.S. economy, appear to have been designed to maximize bad incentives for 363 00:36:27.560 --> 00:36:32.800 future reckless lending and borrowing by the institutions affected by them. 364 00:36:32.800 --> 00:36:39.360 Indeed, I think that the Fed, probably the worst things it's done in its whole history 365 00:36:39.360 --> 00:36:45.040 are the bailouts it's engaged in in the recent crisis because they are setting the stage 366 00:36:45.040 --> 00:36:52.440 for an even greater moral hazard problem in the future and even more disastrous crises 367 00:36:52.440 --> 00:36:59.260 in the future. Central bankers will like to remind you or like to claim that the great 368 00:36:59.260 --> 00:37:05.420 English journalist and economist Walter Badgett was the one who said that we should be grateful 369 00:37:05.420 --> 00:37:10.500 to have them as lenders of last resort. Badgett wrote a book called Lombard Street where he 370 00:37:10.500 --> 00:37:15.580 He did recommend that the Bank of England act as a lender of last resort, and that's 371 00:37:15.580 --> 00:37:22.020 where the idea for having central banks do the same elsewhere came from. But what most 372 00:37:22.020 --> 00:37:26.900 economists don't tell you, and most of them don't know, is that Badgett in writing that 373 00:37:26.900 --> 00:37:32.100 book admitted that it would be better not to have a central bank at all, that it would 374 00:37:32.100 --> 00:37:37.780 have been better if England never gave monopoly privileges to the Bank of England. He recommended 375 00:37:37.780 --> 00:37:43.740 and the last resort lending rule as a way to minimize the harm done by the Bank of England 376 00:37:43.740 --> 00:37:47.060 to a system that it had rendered unstable. 377 00:37:47.060 --> 00:37:53.220 And here's his concluding passages from Lombard Street where he makes it very clear that although 378 00:37:53.220 --> 00:37:59.060 I've suggested, pointed out a deep malady and only suggested a superficial remedy, the 379 00:37:59.060 --> 00:38:03.980 lender of last resort, I've tediously insisted that the natural system of banking is that 380 00:38:03.980 --> 00:38:07.580 where many banks keep their own cash reserves, and so on. 381 00:38:07.580 --> 00:38:14.660 So, Badgett, I'm going to rush through this, but Badgett did make this recommendation, 382 00:38:14.660 --> 00:38:18.420 but it was because he thought at that time you could never get rid of the Bank of England, 383 00:38:18.420 --> 00:38:24.340 so it was the best solution he could come up with. 384 00:38:24.340 --> 00:38:26.180 Do I want to push back the clock? 385 00:38:26.180 --> 00:38:27.780 Is that what I'm arguing for? 386 00:38:27.780 --> 00:38:28.780 I'm not. 387 00:38:28.780 --> 00:38:32.580 I'm not saying that the old system before the Fed was ideal or that we should be happy 388 00:38:32.580 --> 00:38:49.580 What I am suggesting though is if people thought in 1907, after the panic of 1907, that the system isn't working and we need something else, they have just as much reason, if not more, for thinking that today. 389 00:38:49.580 --> 00:38:56.580 Our system has not gotten better since the panic of 1907. The Fed has not delivered on its promises. 390 00:38:56.580 --> 00:39:01.580 I was going to say something about Canada but I don't have time and about the gold standard. 391 00:39:01.580 --> 00:39:31.580 But I will say something about the Wizard of Oz. What I really hope to accomplish with this kind of talk, and with a long paper I've written with some colleagues that's aimed at the mainstream economists, isn't though to propose any particular reform, but to get people away from the complacency about the Fed and thinking of it as the only system that we could possibly have and one that is at 392 00:39:31.580 --> 00:39:34.580 at least better than anything we've had before. 393 00:39:34.580 --> 00:39:37.740 Whenever I think of Ben Bernanke or Greenspan, 394 00:39:37.740 --> 00:39:40.340 I always think about this scene in The Wizard of Oz, 395 00:39:40.340 --> 00:39:42.500 where there are wizards there and you've got the steam 396 00:39:42.500 --> 00:39:46.380 and the mirrors and the colored lights and all that. 397 00:39:46.380 --> 00:39:49.700 And I see myself as sort of the Toto 398 00:39:49.700 --> 00:39:52.660 of Federal Reserve critics. 399 00:39:52.660 --> 00:39:55.180 I want to move that curtain away 400 00:39:55.180 --> 00:39:57.420 and expose this institution, 401 00:39:57.420 --> 00:40:00.980 revealing the fact that it is a very frail, 402 00:40:00.980 --> 00:40:04.260 Very unsuccessful arrangement. 403 00:40:04.260 --> 00:40:08.740 Not something we should regard as the last word 404 00:40:08.740 --> 00:40:11.060 in monetary regimes. 405 00:40:11.060 --> 00:40:13.860 So with that, I will close my talk 406 00:40:13.860 --> 00:40:15.380 and thank you all once again. 407 00:40:15.380 --> 00:40:17.380 Thank you very much.