Hall of Mirrors (courtesy, Oxford University Press)
Barry Eichengreen is the George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley. He is also one of the great economic historians of our time. His new book, “Hall of Mirrors: The Great Depression, The Great Recession, and the Uses – and Misuses – of History,” compares the Great Depression and the recent financial crisis in detail, looking at both similarities and differences in the underlying causes of these crises and the ways policy makers responded to them. I asked him several questions via e-mail about the arguments he makes in the book.
HF – Your account points out similarities between the Great Depression and the recent financial crisis (e.g. bad decisions to let financial institutions go bust, foolish investor beliefs about currency stability and the emergence of poorly regulated shadow banking systems in the U.S.). Yet you also point out many crucial differences between the two periods, and emphasize that no monetary policy will suit all times and circumstances. Put bluntly, if the cases aren’t comparable in many ways, what’s the benefit of studying the last depression for people interested in figuring out the current one?
BE – Differences as well as similarities can be revealing; both can be instructive when it comes to responding events. Building on your question, recall how in the book I emphasize the much greater importance of shadow banking and financial derivatives in the current crisis, as compared to the 1930s. I then go on and make some critical observations about how policy makers, when responding to the recent crisis, focused on stabilizing the banks while doing too little to anticipate and address problems in the commercial paper market, the repo market, and the money market until very late in the game. What are the “benefits” of this kind of observation, you ask? For one thing, there is value, in and of itself, to understanding where we went wrong. For another, seeing that policy makers were inadequately cognizant of changes in the structure of the financial system last time may encourage at least some of them to be more cognizant of such changes in the future.
HF – If Reinhardt and Rogoff wrote about how “This Time is Different,” your book is often about how “This Time Is The Same.” You document how policy makers often try to fight the last crisis, convincing themselves that their present difficulties reflect past ones. This can have surprisingly beneficial consequences (when the erroneous and pernicious ‘real bills’ doctrine helped get policy makers to focus on maintaining credit in the Great Depression), and surprisingly unfortunate ones (when Ben Bernanke’s deep study of the Depression leads him to make mistakes). How can economists and policy makers evolve from being the unwitting slaves of past economic crises towards a more sophisticated understanding? Or can they?
BE – You seem to be asking two questions. One, how can we get policy makers to think outside the box? Two, how can we get them to think outside the historical box, so that they avoid being slaves to a standard potted history? A sophisticated understanding of history requires actually studying history. To take the case of U.S. presidents as an example, some have been better students of history than others. You can fill in the names. But to take one example, JFK actually took the time to write a little history book that ended up winning a Pulitzer Prize. (JFK’s authorship may be disputed, but his historical sensibility is not.) Kennedy had historians, including Arthur Schlesinger, in his kitchen cabinet. In the Cuban Missile Crisis, foreign policy specialists tell us, the president weighed a range of historical analogies and tested them for fitness to the case at hand. He was able to utilize historical evidence in a more sensitive and, ultimately, productive way than, for example, Harry Truman’s single-minded reliance on the Munich analogy when that earlier president was faced with the Korean crisis.
More generally, how can we get policy makers to more regularly think outside the box? I’m not sure I have any special insight into that question. I might turn it around and ask you: how can we get economists to think outside the box?
HF – Friedman and Schwartz’s account of the Great Depression has had an extraordinary influence on our understanding of economic crises. How did their ideas shape the response to the recent financial crisis? Which aspects of their account do you agree with, and which disagree with?
BE – Friedman and Schwartz taught us that it is disastrous to allow money and prices to collapse in a crisis. They left the implication that stabilizing the money supply and price level is necessary and sufficient for preventing the worst. We learned from the current crisis — when policy prevented money and prices from collapsing — that this is not enough to ensure financial instability. In addition targeted interventions are also needed to stabilize financial institutions and markets when the latter are engulfed in a crisis. I would add that we also learned that, in a deep crisis when interest rates fall to zero, monetary policy — Friedman and Schwartz’s preferred instrument — loses much of its potency and have to be supplemented by (gasp!) expansionary fiscal policy. I also think, as alluded to earlier, that Friedman and Schwartz’s focus on bank failures and banking panics in the 1930s was conducive to neglect, until late in the game, of instability in the shadow banking system.
Friedman and Schwartz tell a heavily, though not entirely, “closed economy story,” where the crisis originated in and then infected the United States. My view has always been that the Great Depression was a global crisis — that it was transmitted internationally and indeed amplified by the operation of the international gold standard. I argued that in my 1992 book and, not surprisingly, I argue it also in “Hall of Mirrors.”
HF – One theme of your book is that the relationship between illiquidity and insolvency is often more ambiguous than one might imagine, and that policy makers should ensure that fears generated by the former do not become self-fulfilling prophecies of the latter. How can policy makers distinguish between illiquidity problems that they don’t need to worry about too much, and those that might turn into destabilizing panics about insolvency with systemic consequences?
BE – Yes, liquidity crises can sometimes result in, or themselves produce, solvency crises. You ask how policy makers can distinguish illiquidity from insolvency, how they can determine when illiquidity is most likely to lead to insolvency, and how they should respond. The very premise, with which I agree, suggests that the line between illiquidity and insolvency is hard to draw, and that it can be a moving frontier. The lesson I draw is that policy makers need to respond aggressively to liquidity crises when they surface. This may create moral-hazard problems, but those are problems for another day — for future regulators as opposed to current monetary policy makers.
HF – Your book suggests that the prospects for real reforms, which might stave off major crisis for another generation or two, are bleak. Not only are modern financial institutions too complex to reform easily, but we didn’t have a bad enough crisis to undermine the political power of the actors blocking reform. Are we doomed to have another crisis, and a worse one, before real change can happen?
BE – My book ends on a pessimistic note: that our very success in avoiding a repeat of the worst crisis in 80 years means that we are likely to experience another such crisis in considerably less than 80 years. Because we avoided complete collapse of the banking and financial system like that which occurred in the 1930s, the prevailing system was not discredited to the same extent. The opponents of financial reform were able to regroup and mount resistance to more far-reaching regulatory action of a sort that I’m convinced is still necessary to limit risks to financial stability. This is not to argue that we would have been better off letting the banking and financial system collapse in 2008-9. But the irony is that success was also the mother of failure.
Earlier book interviews on the politics of the financial crisis:
Dan Drezner: Austerity is still popular despite an abject record of failure
Jonathan Kirshner – The US-led global economic order is dying
Eric Helleiner: The G20 didn’t help much during the financial crisis.
Cornelia Woll: Bailing out banks is not a lucrative business
