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The Baseline Scenario
Waiting For The Federal Reserve’s Next Apology
Posted: 14 Aug 2009 05:18 AM PDT
In November 2002, Ben Bernanke apologized – for the Fed’s role in causing the Great Depression of the 1930s. “I would like to say to Milton [Friedman] and Anna [Schwartz]: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again” (conclusion of this speech).
Bernanke’s point, of course, is that the Fed tightened monetary policy inappropriately – and allowed banks to fail – in 1929-33. And much has been made of his strong focus, over the past year, on avoiding a repeat of those or closely related mistakes (including here).
But today we need a different kind of apology, or at least a statement of responsibility, from Ben Bernanke and the Fed.
From the Federal Open Market Committee meeting transcript of August 2003, we know that Bernanke said, “Despite the good news, I think it’s premature to conclude that we should not consider further rate cuts, if not at this meeting then at some time in the near future depending on how the data play out” (p.63).
He was concerned not just to keep interest rates low for a prolonged period but also to signal this to financial markets, “To the extent that we can sharpen our message that economic growth no longer implies an immediate and automatic policy tightening, we should make every effort to do so” (p.65; see also his role in the broader discussion around p.93).
This was, of course, at a time that the speculative fever and outright malpractice in the housing market was really taking off. The build-up of financial market risk was starting to head towards system-threatening dimensions. And many consumers were being set up for a trampling of epic proportions. It is striking there is barely a mention of these issues in the FOMC transcripts.
And that’s the issue. We can argue for a long time about whether the Fed should have tightened earlier. Defenders of the Fed will say the data were ambiguous – and will point to the serious discussion of these issues in the FOMC transcript.
We can also dispute whether or not the Fed should have said anything in public about the impending housing-financial-consumer-taxpayer doom, or tried to tighten regulation. “It’s not our job” or “we don’t have the powers,” or “the politicians wouldn’t have supported us” is what senior Fed people now whisper around Washington.
But this and other FOMC transcripts make it clear that the senior Fed decision makers were not even thinking about the first order financial sector issues. They weren’t aware of what the big investment banks were really doing – show me the intelligence reports before the FOMC or the analytical discussion that indicated any degree of worry. No doubt someone somewhere in the Federal Reserve system was thinking critically about finance – feel free to send me any relevant details - but from the point of view of evaluating the institution, it only counts if the top decision-making body at least has the issues on the table.
We have transcripts so far through the end of 2003. Others should be forthcoming soon; there is supposed to be only a 5 year lag in their publication. But, given their likely content, it would not be a surprise if the appearance of these transcripts slows down.
At this moment of potential regulatory reform, who within the Fed really wants us to know that their leadership in the Greenspan era completely framed the problem wrong, didn’t understand what was happening, and repeatedly, brazenly, and callously ignored the damage being done to consumers?
I fully understand that financial market considerations are not the established focus of central bank interest rate deliberations. But the scope and nature of such deliberations has changed a great deal since the founding of the Fed almost 100 years ago. As the economy changes, central banks have to adapt their conceptual frameworks and our broader regulatory frameworks need to change also. We’ve done this many times before, and we need to do it again.
Huge problems were missed by people using anachronistic conceptual frameworks. Those frameworks should change. This was the assessment of Ben Bernanke, building on Friedman and Schwartz, for 1929-33, and this should be our assessment today.
Our top monetary policy makers completely missed the true nature of the Great Bubble and its consequences, until it was far too late. They should apologize for that and we can start work on redesigning the institution, its decision-making, and how financial markets operate, to make sure it won’t happen again. And it would also be nice if the Fed could avoid adding insult to injury – and stop opposing the administration’s consumer protection proposals.
Hopefully, this time the Fed’s apology won’t take 70 years.
By Simon Johnson

Health Care’s Senior Moment
Posted: 13 Aug 2009 06:30 PM PDT
Seniors have recently emerged as an important battleground in the health reform war. Katharine Seelye of the New York Times has a post on the “new generation gap” separating the elderly from the not-so-elderly, and multiple polls have shown that seniors are more resistant to reform, at least when it is phrased broadly. In addition, the nonsense about “death panels” has worried at least some seniors, enough for the AARP to pitch in to try to shoot it down.*
This should seem ironic, given that people over 65 are the one group that has already most benefited from health care reform – only their reform happened in the 1960s, when Medicare was created. But hey, it’s a democracy, and people don’t have to wish for others the benefits they themselves enjoy.
What are the underlying reasons why seniors are more likely to oppose “reform?” The first – leaving aside the self-contradicting notion that health care reform will mean a government takeover of Medicare – is probably fear that Medicare will be negatively affected. Now, there is a grain of a partial truth to this fear. Several of the proposals on the table include paying for health care reform (meaning, paying for the subsidies that poor people will need if we’re going to mandate universal coverage) in part by reducing growth in Medicare spending. One proposal is the Independent Medicare Advisory Committee, which would look for ways to increase efficiency in Medicare, which could include lower reimbursements for procedures that were deemed to be not providing benefits commensurate with their costs.
To its credit, here’s what the AARP** has to say about health care reform and Medicare:
What do the proposals say? It’s true they all seek to save billions from Medicare costs—not by cutting benefits, but by setting up new ways to pay doctors more fairly and to reward providers for quality of care instead of (as now) paying them a fee for each separate service; reducing waste and fraud; and reducing preventable hospital readmissions.
All the proposals would cut the amount of subsidies now paid to Medicare Advantage private health plans, which cost an average of 14 percent more per person than traditional Medicare does. Without subsidies, the private plans could become more efficient, or they could raise premiums, reduce benefits or withdraw from Medicare.
The proposals also add benefits to Medicare­—such as covering more preventive services and narrowing the Part D “doughnut hole.”
More fundamentally, though, the need to reduce growth in Medicare spending stems from the simple fact that otherwise Medicare will blow through the entire Federal budget within the next few decades. Not reducing the Medicare growth rate is not an option. If I were a senior, or expected to be one in the next couple decades, I would very much want health care reform now, because the alternative will be much more draconian cuts to Medicare benefits in the future as the national debt explodes.
And reducing costs is precisely the other thing that seniors care about. According to Seelye, concern about health care costs rises with age. Now this makes sense; even with Medicare, seniors’ out-of-pocket medical expenses are considerably higher than those of younger people, for the simple reason that on average they consume more medical care. But there’s no good way to reduce seniors’ out-of-pocket spending without at the same time reducing Medicare spending because, broadly speaking, those two types of spending are buying the same thing – health care. You can’t have a system where Medicare spends more and more yet seniors spend less and less out of pocket (short of simply reducing seniors’ relative contribution to their health care costs, which would only make the fiscal problem worse).
It’s simply contradictory to oppose reductions in the growth rate of Medicare spending while favoring reductions in your out-of-pocket spending. Of course, there’s nothing that prevents people from holding two logically inconsistent thoughts in their heads at the same time. Uwe Reinhardt had a brilliant column a couple of weeks ago on the stew of inconsistencies that many Americans take for granted when it comes to health care.
Luckily, they elect representatives who can think clearly about these complex issues. Oh, wait, sorry about that.*
* On the other hand, what the hell does Chuck Grassley – one of the six people who think they are writing the health care bill – think he’s doing, saying “We should not have a government plan that will pull the plug on grandma?” As Brad DeLong might say, why oh why does he have a seat at the table?
** As far as I can tell from their website, the AARP is neither for nor against health care reform in general; they say they are working to make sure that health care reform is good for their constituency.
By James Kwak