First published: Financial Times, 02/09/2008
A former US Treasury secretary, Andrew Mellon, once said the solution to the crash of 1929 was to liquidate labour, liquidate stocks, liquidate the farmers and liquidate real estate. He thought, as many do today, that the biggest danger to the economy was not what we now call de-leveraging, but inflation. For him, the only solution to the crisis was to let inflation drop. However, R.G. Hawtrey, formerly of the UK Treasury, argued in A Century of Bank Rate that a similar economic policy in Britain in 1930-31 – to focus on inflation – was the equivalent of crying “‘Fire! Fire!’ in Noah’s flood”.
This historical debate has resonance today. There is a rising chorus of protest at the unorthodox policy actions undertaken by central banks, especially the US Federal Reserve, and by more activist governments. How far is this protest justified?
The Fed has been criticised for the technical ways in which it has provided liquidity to markets, notably for lending to investment banks, which it does not supervise, on the same terms as it lends to commercial banks, which it does. The Fed has also been accused of acting, in effect, as a covert agent of the US government, by using its balance sheet to aid the takeover of Bear Stearns. However, in my view the Fed has been obliged to do unusual things to avert a systemic financial meltdown. I see nothingin its operations that is irreversible and cannot be undone a…more
