Have We Learned Our Lesson?

THE BE YOUR OWN ECONOMIST ® BLOG

The following reworks yesterday’s posting:

The federal government’s new plan to invest in the nation’s banks, guarantee their loans and insure their deposits is welcome news. It borrows from European initiatives launched over the weekend and improves upon our own bailout package.

But many people will ask, “What took us so long? We led the world into crisis, why couldn’t we lead the world out of crisis?”

Most economists said Federal Reserve Chairman Ben Bernanke’s research on the Great Depression of the 1930s well-prepared him for the job. They believed that Mr. Bernanke’s scholarship would help him avoid the kind of crisis that recently befell us.

Mr. Bernanke endorsed the conventional wisdom that the Fed’s high-interest-rate policies in the 1930s turned a run-of-the-mill recession into the Great Depression. Instead, the argument goes, the Fed should have reduced interest rates to stimulate borrowing and spending.

The view that misguided government policy caused the Great Depression soon became part and parcel of the notion that government can’t do anything right. Few stopped to ask: “Just because a policy failed, why does that condemn all government action?”

Recently, under Chairman Bernanke, laissez faire principles motivated the Fed to maintain a hands-off, minimalist approach. The Fed let low interest rates and lax lending standards inflate the real-estate bubble. When the bubble began to deflate and mortgage-backed securities instigated the global financial crisis, the Fed and the Treasury underplayed the problem. Instead of taking a systematic and systemic approach they proceeded in an ad hoc and piecemeal fashion. Eventually credit markets became so impaired and the emergency so pronounced, the Fed and the Treasury felt compelled to reverse course and implement a comprehensive government rescue of the financial system.

What an irony. Economists endorsed Mr. Bernanke because they believed he had learned from mistakes the Fed made during the Great Depression. But those lessons were clearly insufficient to avert the recent crisis. The real lesson is that blind adherence to free-market principles, not government action, was the chief culprit this time. On occasion a wise, well-informed and intelligent pragmatism is what’s really needed.

© 2008 Michael B. Lehmann