Great Leap Forward


We finally can know what the Fed officials talked about in their FOMC meetings in 2007 as the economy crashed all around them: FT report here; and Fed’s transcripts here

After the Greenspan fiasco, when Rep. Henry Gonzalez caught him fibbing about recordings of Fed meetings (Greenspan denied that the Fed kept them, but actually did meticulously record and transcribe them), the Fed agreed to release the transcripts with a five year lag. They’ve finally released transcripts from 2007–the year the crisis began.

We knew they were clueless as US financial markets bubbled to the greatest speculative peak ever from 2000 to 2006, and we knew the Fed waited far too long to act like a central banker when the crisis hit. Now we know that even after the crisis hit, they remained clueless.

I’ve previously reported on a speech given by Fed Governor Freddie Mishkin at the Levy Institute in early 2007–after it was obvious to many of us that US financial markets were crashing–in which he focused on supposed inflationary threats while ignoring the tidal wave of defaults on subprime mortgages that had already began. (See Freddie Does Iceland:; see the footnote below for a summary.)

And now we know that he wasn’t just pitching the party line. He really believed the nonsense. The August 2007 minutes find him thrilled, yes, thrilled! that markets were rattled:

“Basically what I think is happening in a way is quite a good thing: We were  concerned that the markets were a little too optimistic, that there was too much  opacity, and that people weren’t worried about it. Now, in fact, they are  worried about it, and I think that is fundamentally a healthy situation.”

Yes, Freddie’s prognostications about the US situation were about as useful as his consulting work for Iceland in which he proclaimed Iceland’s banks superduper healthy. (They immediately crashed in an historically spectacular manner.)

But Freddie wasn’t the only one. Donald Kohn, who’s long been given kudos as the brains behind the Fed when he was the data wonky staff member who advised Chairmen–and then was promoted to Vice President of the Fed’s Board–was almost as clueless. He foresaw only a minor hiccup for US economic growth:

“My forecast for the most likely outcome for output over the next few years is … growth a little below potential for a few quarters, held down by the housing  correction, and the unemployment rate rising a little further.”

Yep unemployment might rise a wee bit. As in 25 million people still looking for full time jobs five years later. Deepest recession and worst financial crisis since 1930.

And what a housing “correction”! Is your house price “corrected” yet? Feel better now?

And there’s much more to come, folks. Looks like 1937 all over again.

Footnote from my piece, Freddie Does Iceland:

At the very beginning of the US financial crisis (April 2007)—when most still did not see it coming—Mishkin as member of the BOG gave a dinner speech. There was no indication in his speech that he “saw it coming”—he predicted moderate growth, emphasized some strong data in housing as well as low unemployment, and said the Fed would keep its interest rate target at 5.25. While it is hard to believe now, the Fed and most of the press was still worried about inflation at that time—even though anyone who was paying attention could see the economy was beginning to collapse into what would obviously be the worst crisis since the Great Depression. Still, commodities prices were being driven by a speculative boom coming mostly from pension funds—a story for another day. So Freddie was peppered with questions from the media present asking whether the Fed would be able to prevent an inflationary burst. Mishkin’s response was eerily similar to the response he gave in the video—you’ve got to trust the central bank. Do not worry, the Fed has ample ammunition to kill inflation.

When he returned to our table, we grilled him a bit more on that topic, and some of us also argued that the real danger facing the US was a financial crisis and deflation—not inflation. Let me interject that I liked Mishkin. He was a pleasant conversationalist, not at all arrogant, and even somewhat self-effacing. But when he gave his pat answer, “don’t worry, we are the Fed and we know what we are doing”, Jamie Galbraith pressed him for details: what are you going to do about inflation? And, if you raise interest rates now, when debt loads are so high, won’t that cause a wave of delinquencies on mortgages and consumer debt? That’s when we saw the same transformation you just witnessed in the video—from an easy, affable, confidence to sheer horror. Mishkin had been found out and was looking for the exits.

I must say that it was never clear exactly what that horror was. At the time I did not believe that Mishkin’s heart was in the inflation story. Surely he could not have believed, then, that the real danger was inflation. He’d been coached at the Fed about what he ought to say—and the Fed was riding the inflation story to divert attention away from the real danger. The Fed needed to keep the speculative bubbles going as long as possible—an election was around the corner and Republicans needed help. I was sure that he was actually afraid that we were right: the economy was going bust. And the Fed had nothing up its sleeve to prevent Armageddon.

Shortly thereafter, Mishkin left the Fed (August 2008—the second-shortest term ever served). That looked suspicious—and although I never tried to find out why, it fit with my interpretation that he knew what was coming, and so like Greenspan jumped the sinking ship before the Fed would be exposed as the impotent Wizard of Oz behind the curtain.

However, since then, Greenspan has publicly admitted that he had been clueless. His whole approach to economics was dangerously wrong. He never saw nothing coming. And after viewing this video, I am not so sure Mishkin had any clue, either.

Maybe his term at the Fed, like his research for Iceland, was nothing but marketing, too. Columbia professor? Check. NBER researcher? Check. FDIC researcher? Check. Highly paid consultant for international research? Check. Vice President of NYFed? Check. Former BOG member? Check. Top selling money and banking textbook author? You betcha.

All he needed was a few months at the helm of the central bank, something he could add to the textbook blurb, to ramp up those sales.



apjayJanuary 19th, 2013 at 12:44 pm

Hmm … those 2007 transcripts are a bit like waiting for the Armstrong interview … merely confirming what we already knew.. And look at all the harm created over several years while both were denying. What a complete clusterf**k.

Ed Dolan EdDolanJanuary 21st, 2013 at 7:11 pm

Donald Kohn's 2007 forecase for the US economy: “The most likely outcome for output over the next few years is … growth a little below potential for a few quarters, held down by the housing correction, and the unemployment rate rising a little further.”

All I can say is–Wow!

L. Randall Wray L. Randall WrayJanuary 23rd, 2013 at 6:50 pm

Ed: Yep, housing certainly held growth down a wee bit!
Take a look at the January transcripts. Indeed, I urge all of you to take a look at the transcripts. For example, read the January 2007 transcripts (all 255 pages of them!). True, not many mainstream economists saw anything coming that early (as the Queen remarked), so the Fed was not alone. But look at what they discussed (for 255 pages). Inflation. Inflation. Inflation. And then quibbling over the exact wording to be used in their statement, arguing about how it might be interpreted to actually MEAN something. And then page after page after page on how to present themselves in public without appearing to disagree or to say anything important. These are supposed to be the people running our economy, and more important, keeping our financial system safe. There is almost no discussion of financial institutions or their practices. At the peak of the biggest financial bubble in human history! On the verge of the worst calamity we had seen since 1929. And they are quibbling about whether the inflation target ought to be a few basis points higher or lower. On one hand I’m always a bit relieved to read the transcripts–there is no grand conspiracy against labor. And I’m always impressed with the apparent intelligence (altho after they found out that Greenspan had recorded every word uttered, they presumably knew to bring notes with them!). But it is just shocking what they believe to be important.

PZJanuary 25th, 2013 at 4:07 pm

Isn't the basic problem here that they don't recognize existence of wealth effect? (at all?)

That it is not in their models and that's why housing wealth increase was supposed to be meaningless?

PZJanuary 28th, 2013 at 7:11 am

Mr. L. Randall Wray, are you ignoring me?

Have I hurt your feelings in any way?

After all the work I have done to popularize MMT, this is how you treat me?

I have have written to you before but seem never get any answer.

How sad.

LRWrayJanuary 29th, 2013 at 12:56 am

a) i don't respond to every comment, especially those on "older" posts after a newer one is posted.
b) i do not tend to remember any "handles"; I do better with proper names. So I have no idea if I have tended to ignore you, or if you have done a lot of work to popularize MMT. In either case, the oversight was not intentional
c) with regard to your question: NO, even orthodox do not completely ignore wealth effect. Greenspan during the dotcom boom specifically included it.
that leaves me puzzled as to what your question is all about?

PZJanuary 29th, 2013 at 4:10 am


I'm just worried it seems to be completely missing out from the debate. Mainstream economists argue that what really matters is how people spend out of their income, that is mainly influenced by psychological factors, like "confidence" and "expectations". That's their whole theory of business cycles, really.

You got people like Paul Krugman arguing for or against stimulus measures based on their supposed psychological factors. You got Krugman wondering why avarage Chinese saves so much even though his wealth is only 1/20th that of average americans. You got Martin Wolf seriously suggesting US debt to GDP ratio would rise to 200% GDP if raising costs of health care spending would not be contaiden or paid for by increasing taxes. He never considers what would happen to GDP deflator if you tried to give wealth equivalent to two time your GDP to citizens.

They argue as if wealth did not matter at all.

At the same time, I don't hear MMT economist say anything about wealth either. I understand that left-leaning economists don't want to talk about wealth effect because it gives credibility to the 'pigou effect' argument, that lowering wages could fight unemployment. At the same time right-wing economist don't want to talk about it because it implies that ordinary people should have money and wealth to continue consuming. So they both play it down.

When nobody talks about it nobody understands it, and end result is a disaster!

lrwrayJanuary 30th, 2013 at 12:41 am

Sorry do not understand your complaint. In the boom, millions of USA homeowners borrowed against equity to finance consumption. Recognized by all sorts of economists including Greenspan.

Unsustainable trends (health care in america) will not be sustained.

If you think MMT ignores wealth, read my Primer. Chapter 1 will dispel your misconception.

PZFebruary 3rd, 2013 at 11:48 am

My question is this: why does Paul Krugman, Martin Wolf ignore wealth effect associated with sovereign debt so completely?

If mainstream explanation for business cycles is confidence and expectations, what is the MMT explanation, really?

I mean, if mainstream economist were to challenge you to a debate over drivers of the economic fluctuations, and they would claim it's all about psychological factors, what would you say to them?

Actually, it would be quite useful debate to have. I think they are missing something big here. It's hard to even understand how they have come to the conclusion that wealth does not matter, except housing wealth for some odd reason. But they are clearly there.

Understanding wealth sould be economics 101. Now we see them tripping over simple, trivial issues over and over again. It's just horrible to watch.

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