Jeffrey Rogers Hummel Tells Us How the Fed Got So Damned Big

Before he became chair of the Federal Reserve,
Ben Bernanke agreed with the free market economist Milton Friedman
that central bank policy played a key role in making the Great
Depression the most severe in U.S. history. But the two parted ways
on the reason why. And that disagreement goes a long way toward
explaining why the financial crisis of 2007-2009 has brought not
just a dramatic increase in the powers and activities of the
Federal Reserve but a fundamental transformation of its role within
the economy.

Friedman viewed banking panics as monetary shocks, in which the
checking accounts and other deposits at failing banks wink out of
existence, causing a sudden fall in the total money supply. In
contrast, Bernanke treats panics as shocks to the flow of savings,
causing the failure of firms whose continued existence is crucial
for the allocation of credit. Such disparate diagnoses dictate
significantly different cures.

If the danger from bank panics is primarily a collapse of the
money supply, then the proper response is a general injection of
money by the central bank. The survival of particular financial
institutions is of secondary significance. On the other hand, if
the danger comes from key financial institutions failing and
choking off credit, then the proper response is bailing them
out.

View this article.