In Greg Ip’s new book, Foolproof, he writes,

Frederic Mishkin, an expert on banking who had studied the Great Depression, examined what would happen if housing prices fell 20 percent. The Fed, he argued in a lengthy presentation to other central bankers, would lower interest rates quite quickly, the economy would shrink only 0.5 percent, and unemployment would barely rise.

I have not yet read Bernanke’s new book, but I gather that he thinks that without the bailouts the economy was headed toward another Great Depression. So my point is that there is quite a gap between what Mishkin thought would happen if housing prices fell and what Bernanke was afraid was going to happen. Some possibilities.

1. Mishkin actually was right. The economy easily could have withstood the housing price crash. The problem must have been something else. (Scott Sumner would say that it was tight money.)

2. Mishkin was working with a simplistic model of the economy, which did not include the fragility of the financial sector or the feedback from loss of confidence in banks to the rest of the economy. There are two variations on this view

a) the bailouts helped, just as Bernanke says they did.

b) the bailouts made no macroeconomic difference. They simply served to redistribute losses away from the some of the stakeholders in the bailed out firms.

3. Mishkin actually was right. The economy would have recovered quickly with only a small recession. However, Bernanke and other policy makers did the wrong thing and turned what would have been a short-term crisis and the failure of a few firms into a long, drawn-out period of slow growth.

I think that (2a) is the most generally accepted view. My own view is 2b. I could also make a case for (3). Note that in the Great Depression, both Hoover and Roosevelt thought that destructive competition was a major problem. Both tried to discourage businesses from competing, Hoover through exhortation and Roosevelt through the National Industrial Recovery Act. In hindsight, reducing competition was a counterproductive idea. Perhaps in hindsight TARP and the other bailouts will not look so good, either.

By the way, I can offer a lot of praise for Ip’s economic judgment. However, I think I will end up putting Foolproof in the “very good but could have been even better if. . .” category.