Did Bernanke really prevent another Great Depression?

In his speech to Dallas business leaders, Richard Fisher, the Dallas Federal Reserve president, said that the US central bank's actions stopped the economy from falling into depression. According to Fisher the Fed has done all in its power to avoid the policy misjudgements seen in 1930's. In his speech the Dallas Fed chief praised the Fed Chairman Ben Bernanke for initiating the rapid response to the emerging calamity."It's easy to second-guess a general after the war has subsided," Fisher said, terming Bernanke an "exemplary public servant" who "applies very considered judgement."

“The Fed, under Bernanke's stewardship, has prevented another economic depression in the United States”, Fisher said. "Your central bank has worked hard to pull the economy back from the abyss."

So what exactly did the Fed do to prevent the disaster? Under the guidance of Ben Bernanke the US central bank has lowered the federal funds rate from 5.25 per cent in September 2007 to the current level of 0 per cent. Since September last year the Fed has boosted the pace of money pumping through an aggressive expansion of its balance sheet. (The Fed has been buying assets and paying for this with money out of “thin air”).

As a result the yearly rate of growth of Fed's balance sheet jumped from 3.9 per cent in August last year to 152.8 per cent by December 2008. The size of the balance sheet climbed from $0.9 trillion in August last year to $2.1 trillion by April this year. In response to all this pumping the growth momentum of our monetary measure AMS* has accelerated. The yearly rate of growth jumped from 2 per cent in August 2008 to 13.8 per cent by June this year.

The question that needs to be addressed is how can the massive pumping and massive lowering of interest rates prevent an economic disaster? Careful analysis would show that all that these actions can do is to redistribute existing real savings, or real wealth, which is necessary to support economic activity. Remember that if money pumping could by itself fund economic activity then world poverty would have been eradicated a long time ago.

All that aggressive Fed policies have achieved is a further weakening in the process of real wealth formation. This in turn has only weakened and not strengthened the economy's ability to grow. The only reason why the US economy didn't fall into a depression is because the pool of real savings is still there. Hence contrary to Fed's policy makers thinking we can only suggest that US central bank's aggressive policies have raised the likelihood of the US economy falling into a severe economic slump on account of weakening the mechanism of real wealth generation.

*AMS is defined as currency plus demand deposits with commercial banks and thrift institutions plus saving deposits plus government deposits with banks and the central bank. This definition reveals very clearly that monetary expansion takes place as a result of central bank injections of cash and the commercial banks’ practice of fractional reserve banking.

Frank Shostak

Frank Shostak is a former professor of economics and M. F. Global's chief economist.

Also by Frank Shostak