In Inflationphobia, Part III, Bruce Bartlett concludes his series. Part I is here and my comments here. Part II is here and my comments here. In each I took issue with one paragraph. I do the same now with the very first paragraph (which does not mean I don´t agree with other parts of the post):

When the most recent recession began in December 2007, there was no reason at first to believe that it was any different from those that have taken place about every six years in the postwar era. But it soon became apparent that this economic downturn was having an unusually negative effect on the financial sector that threatened to implode in a wave of bankruptcies. The Federal Reserve reacted by doing exactly what it was created to do — be a lender of last resort and prevent systemic bank failures of the sort that caused the Great Depression and made it so long and severe.

This has been the conventional wisdom about the “Great Recession”. The recession became “great” because of the accompanying financial crisis and, furthermore, we should be thankful that the Fed reacted appropriately and “did what it was created to do…”.

He´s right when he says that when the recession that began in December 2007 there was at first no reason to think it was ‘special’. Employment, for example, dropped less during the first 5 or 6 months of this recession than in all other post war recessions. Unemployment, which was 5% in December 2007 climbed only to 5.4% in May 2008, five months into the recession.

The Fed is thought to have saved the economy from plunging into a second great depression. But the Fed is also blamed for ‘instigating’ the financial crisis by having pursued an easy money policy in 2002-05, which fueled the house price boom (and then bust).

In other posts I have argued contra the view that money was “easy” back then and also discussed the house price boom and bust.

It´s not about money being “easy” some years ago but about it being “tight” beginning in 2007! It was tight money that caused both the recession and the ensuing financial crisis.

But that lesson has not been grasped. So now many say that current “easy” money policy is fueling all sorts of bubbles and paving the way for another financial crash, this time accompanied by ballooning inflation! Here´s Ben Powel at Freedomfest:

Inflation is a hidden tax that threatens the savings that people rely on for financial security. And by eroding the purchasing power of savings—the source of private investment and job creation—inflation also undermines economic growth. That most pundits are not worried about the current rate of retail price inflation is irrelevant, Powell explains. What matters far more is that the Federal Reserve has added considerably to the balance sheets of the banking system. The only reason this hasn’t translated into rapidly rising retail prices is that the Fed is paying banks interest on their reserves. Once they stop doing so, we can expect prices to begin to soar soon afterward. The classical gold standard tamed the fiscal behavior of government. But people’s failure to understand this critical point allowed governments to abandon it and usher in an age of inflation. Rome’s emperors assaulted their currency and brought an end to their empire. Will the same fate await the United States?

In early May Nick Rowe published a must read post on this topic: “Monetary stimulus vs financial stability is a false trade-off”. A short sample:

People are not all identical. At any given rate of interest, some will want to borrow and others will want to lend. So some people will actually borrow from other people. Maybe via financial intermediaries. And some of those financial intermediaries issue liabilities that are used as media of exchange and so are called “banks”. And sometimes some people will borrow too much. Which means, of course, that sometimes some other people will lend them too much. Accidents happen, even on safe roads, because some people drive too fast or aren’t paying enough attention. But the biggest accidents happen when an apparently safe road suddenly and unexpectedly becomes unsafe. Because the drivers can’t slow down quickly enough. Or even if one driver can slow down quickly enough, another driver who can’t simply ploughs into the rear of the slowing car. OK, that’s just an argument by analogy. But I think you can see the link. If central banks keep nominal income growing smoothly, most people will adjust their borrowing and lending (speed) to the prevailing conditions. And some won’t, of course. But if the central bank lets nominal income fall, without giving people lots of advance warning, that means that even some otherwise safe borrowers and lenders suddenly become risky, and they crash too. And the best palliative is to get nominal income back onto as close to its previous path as possible as soon as possible. Even if that does cause drivers to speed up, now that the roads are safe again.

As the chart shows, the surprise plunge in nominal income AND the failure to get it back closer to trend remains the best explanation for the both the “great recession” and the weak recovery, both in the US and anywhere else you care to look (in the EZ and the UK, for example).