Book Review: Money in the Great Recession
Reviewed by Nick Ronalds, CFA
Almost everyone has views about the causes of the global financial crisis (GFC). Authors in Money in the Great Recession: Did a Crash in Money Growth Cause the Global Slump? argue that almost everyone is wrong. As the subtitle suggests, the contributors maintain that the culprit was a crash in money growth.
Getting the answer right is important not only to policymakers, whose actions affect economies around the world, but also to financial market practitioners, whose livelihoods depend on the accuracy of their judgments regarding present and future economic conditions.
Students of economic history will remember that Milton Friedman and Anna Schwartz showed in their landmark work — A Monetary History of the United States, 1867–1960 — that a sharp drop in the money supply was the dominant cause of the Great Depression. That seminal work prompted Ben Bernanke to conclude a speech at a conference honoring Friedman on his 90th birthday with this promise, on behalf of the US Federal Reserve and central banks generally: “You’re right. We did it. We’re very sorry. But thanks to you, we won’t do it again.” Money in the Great Recession suggests that this promise was broken.
The book’s editor is Tim Congdon, chair of the Institute of International Monetary Research and a former member of an independent panel of forecasters in the United Kingdom known as the “wise men,” who advised the chancellor of the exchequer in the 1990s. He and eight other leading British and American macroeconomists examine the evidence for causes of the slump in the economies of the United States, the eurozone, the United Kingdom, and Japan.
Congdon (a contributor as well as the editor) is well aware that according to the typical account of the GFC, the culprits are the irresponsible marketing of arcane permutations of mortgage instruments and reckless banks operating on razor-thin capital cushions — “the follies of free-market capitalism.” Money in the Great Recession presents a convincing alternative view.
A chart early in the book shows that money growth rates in the United States, the United Kingdom, and the eurozone exceeded 10% in 2007. The US rate peaked in early 2008 at about 18%. Money growth rates then fell sharply in all three regions. The fall began well before the Lehman Brothers bankruptcy, which is usually fingered as the event that precipitated the GFC.
The United States, the United Kingdom, and the eurozone exhibited similar money growth trajectories, but Japan does not fit the pattern. It had weak money growth before the GFC and faster growth afterward. Nevertheless, the contributors argue, Japan suffered badly in the GFC, largely because its exports slumped as the yen soared. That currency appreciation was triggered by the end of the carry trade as US and eurozone interest rates fell to levels close to Japan’s.
An intriguing chapter by scholar and John Maynard Keynes biographer Robert Skidelsky asks what that great economist would have thought of the GFC. On the basis of letters Keynes wrote while visiting the United States in the early 1930s and other works, Skidelsky believes that “Keynes’s analysis here was identical to — and indeed anticipated by over 30 years — Milton Friedman’s and Anna Schwartz’s retrospective analysis of the Fed’s failure in the 1963 A Monetary History of the United States.” Skidelsky thinks Keynes would have applauded quantitative easing (QE) and that he, in fact, advocated its equivalent in the early years of the Great Depression. At that time, he called it “open-market operations à outrance” (to the ultimate).
Another major theme in the book is the impact of regulatory policies on the depth and durability of the recession. Motivated by the nearly unanimous belief that irresponsibly low capital-to-asset ratios were a major contributing factor in the GFC, governments took steps to increase bank capital. But the premise was dubious, argue several contributors. The ratio of equity capital to total assets for commercial banks was higher in 2008 than at any other time since World War II. The policies’ effects, moreover, were pernicious. As one author puts it, the policies “were the dominant reasons for the pro-cyclical credit crunch of 2009 and 2010 . . . and the plunge in the growth rate of the quantity of broad money from pre-2009 rates.”
Any summary of the book’s key propositions oversimplifies a complex and controversial subject. Two of the volume’s contributors take issue with the others on important points. They argue, among other things, that QE was minimally effective because it triggered financial market actions — “leakage” — that offset its expansionary force. The ineffectiveness of monetary policy at the zero lower bound of interest rates is a widely argued proposition of at least one camp, usually identified as “Keynesian,” in the economic debate. (Ironically, it is not the position taken by Robert Skidelsky, the Keynes biographer.)
The last chapter ends with an observation and a hope: “The Great Moderation was accompanied by a cessation of hostilities in the monetarism–Keynesian debate. In retrospect, it is clear that this debate has long needed revival and clarification.” The pertinent issues continue to be debated, and this splendid volume intelligently contributes to that debate.
Nick Ronalds, CFA, is managing director at Rho Financial LLC, Chicago.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.