TJP

Bernanke Blames Banks instead of Self for Tight Credit

Byron A. Ellis – November 17, 2009

Yesterday, the Federal Reserve (Fed) Chairman Ben Bernanke told members of the Economic Club of New York that economic growth next year is likely. He also blamed tight credit by the banks for preventing a robust recovery. It is interesting how Mr. Bernanke blames others for the economic misery of Americans, when in fact it was the Fed tight money policies that crashed the economy.

The Fed failed to expand the money supply (M1) from 2003 to the fourth quarter of 2008 and it is the Fed tight money policy that restricted the demand for real money balances (see Fed graph StLouisFed.org). Certainly, the banks have taken low or no interest money from the government and jacked up interest rates and curtailed credit limit to consumers. But, Bernanke and the Fed have the power to remedy bank’s behavior.

Bernanke’s inability to free up credit for American consumers validates The Jethro Project's position that he should have not been reappointed.

Anyone that have taken a basic course in macroeconomics is aware that keeping M1 flat for approximately five years would cause adverse economic outcomes.

Mr. Bernanke appeared to recognize the Fed error in targeting inflation at the expense of economic growth. As a result, the Fed has significantly increased the supply of M1 in the fourth quarter of 2008 and beyond. However, the reversal was too late to prevent the loss of middle class wealth. Furthermore, the remedy crafted by Treasury and the Fed to salvage the economy was grossly inadequate.

The Treasury and the Fed failed to identify the root cause of the economic problem, which was loss of real consumers’ income due to a contraction in real money balances. Instead, they identified the root cause as a sub prime problem, resulting in what they coined toxic bank assets. From this misidentification, they developed solutions for the symptom, instead of the cause. And, their solution was to give money to bankers. However, the money should have gone to homeowners to prevent foreclosures.

Consumer spending is between 60 and 70 percent of the gross domestic products (GDP). Therefore, consumers drive GDP not bankers or private investors. Bailing out homeowners in distress would have prevented the so-called toxic assets and maintained middle class wealth (home values). Middle class wealth would have kept a high level of demand for goods and services, as well as robust employment.

The transmission mechanism from bank bail out to employment is unclear, particularly when the bailed out banks have raised interest rates and lowered spending limits on credit cards. High interest rates and borrowing restrictions are counterproductive to economic expansion. Surely, over time the expansion in the money supply will cause economic growth, but in the interim the dreams and efforts of many American will have been devastated, mainly due to administrative mismanagement.

If banks do not want to participate in the restoration of a healthy American economy, the Fed should not continue to provide them low cost money. Rather, the Fed should lend directly to the homeowners and bypass the greedy banks. Economic growth is a matter of national security.

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