Noted Monetarist, Ben Bernanke has been heralded as the savior of the financial system since implementing the historic financial bailouts earlier this year. I’ve been a vocal critic of the focus on Monetary Policy and and I believe that this will fail to materialize into a strong economic rebound for several reasons:
- The programs implemented were too bank focused because Monetary Policy necessarily works through the banking system. This will result in a rescue of the banking system, but not necessarily a rescue of the rest of the entire. In this sense, the bank bailouts were a form of trickle down economics that won’t really trickle down to the middle and lower class thereby resulting in, at best, a weak economic environment.
- There is no transmission mechanism by which these programs could reverberate into the rest of of the economy and solve the actual problem at hand. As I’ve explained many times, this crisis is a household balance sheet crisis. The banks are a symptom, not the cause. Therefore, fixing the banks doesn’t fix the actual problem. It is the households who need the stimulus and balance sheet resolution.
- Banks don’t lend reserves. Traditional Monetarist thinking says that banks obtain reserves and multiply them, however, this is not how banks operate in reality. Banks make loans and obtain reserves after the fact. Therefore, programs like QE are not monetarily stimulative in the sense that some seem to think because it won’t cause banks to lend more.
I fear that, for these reasons, any economic recovery will remain extremely fragile. Our obsessive focus on Monetary Policy has blinded us from the ability to actually solve the root of the problem we encounter.