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I Took His Class. Now He's Being Tested.

"By raising interest rates" after the 1929 crash, "policymakers contributed to soaring unemployment and severe price deflation," Bernanke explained in a Foreign Policy magazine essay in 2000 -- a sharp contrast to the moves his Fed has made this year, slashing the federal funds rate to its lowest level since early this decade.

In the run-up to the Depression, Bernanke argued, better leadership could have made a difference. In a November 2002 speech honoring the economist Milton Friedman, Bernanke, already serving on the Fed's Board of Governors, recounted the tale of Benjamin Strong. As head of the Federal Reserve Bank of New York in the 1920s, Strong opposed the Fed's attempt to curb Wall Street speculation by tightening monetary policy when "there was not the slightest hint of inflation," Bernanke said. But Strong died of tuberculosis in 1928, and his views lost sway.

"We don't know what would have happened had Strong lived; but what we do know is that the central bank of the world's economically most important nation in 1929 was essentially leaderless and lacking in expertise," Bernanke lamented. "This situation led to decisions, or nondecisions, which might well not have occurred under better leadership. . . . And associated with these decisions, we observe a massive collapse of money, prices, and output."

One reason that collapse lasted so long, Bernanke explained in a 1983 paper, was that credit markets "dammed up," falling prices increased the burdens on debtors and financial panics disrupted banks' ability to lend. "Some borrowers (especially households, farmers, and small firms) found credit to be expensive and difficult to obtain," Bernanke wrote. "The effects of this credit squeeze . . . helped convert the severe but not unprecedented downturn of 1929-30 into a protracted recession."

Bernanke praises government efforts to prop up those financial markets in the 1930s, but that does not necessarily translate into support for wider interventions. The notion that massive public works projects ended the Depression is one of the "major errors" people make about the era, he told Snowdon. And although Bernanke once urged Japan to show "Rooseveltian resolve" in getting out of its own economic crisis in the 1990s, his assessment of FDR's New Deal seems lukewarm. "It might be argued that the federally directed financial rehabilitation -- which took strong measures against the problems of both creditors and debtors -- was the only major New Deal program that successfully promoted economic recovery," he wrote in 1983 -- an intriguing perspective, given his recent backing for a new fiscal stimulus package.

Finally, Bernanke fervently believes in the lessons of history. "Those who doubt that there is much connection between the economy of the 1930s and the supercharged, information-age economy of the twenty-first century are invited to look at the current economic headlines -- about high unemployment, failing banks, volatile financial markets, currency crises, and even deflation. The issues raised by the Depression, and its lessons, are still relevant today."

He wrote those words in 2000, long before today's crisis. But even in the midst of the current market meltdown, when Bernanke stood alongside Treasury Secretary Henry M. Paulson Jr. and Federal Deposit Insurance Corp. Chairman Sheila C. Bair on Oct. 14, as the administration announced the injection of hundreds of billions of dollars into the banking system, the Fed chairman again invoked history. "Americans can be confident," he said, "that every resource is being brought to bear: historical understanding, technical expertise, economic analysis and political leadership."

Note the order: History comes first.

So have our leaders truly absorbed the lessons of the Depression? In his speech on Friedman, Bernanke praised "A Monetary History of the United States," the landmark 1963 book by Friedman and Anna J. Schwartz that blamed the Depression on bad monetary policy. His concluding words indicated an awareness of the Fed's past errors but also an abiding confidence in his ability to get it right next time. "I would like to say to Milton and Anna: Regarding the Great Depression: You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

But an understanding of history may only get you so far, other economists argue, especially when we haven't really been transported back to 1929. In an Oct. 18 interview with the Wall Street Journal, Schwartz herself said that Bernanke's historical smarts were his "claim to be worthy of running the Fed" but concluded that "my verdict on this present Fed leadership is that they have not really done their job." And Harvard economist Greg Mankiw, former chairman of President Bush's Council of Economic Advisers, recently suggested that the Treasury and the Fed today face a tougher challenge than that of the 1930s. "Then, the problem was largely a problem of confidence and a shortage of liquidity," he wrote Oct. 26 in the New York Times. "Today, the problem may be more a shortage of solvency, which is harder to solve."

For all our sakes, I hope my old professor has distilled the right lessons from the Great Depression and can discern which do and which don't apply today. If he passes this test, history will grade him generously. If not, I suspect it will be hard for the country to find solace in a new learning opportunity.

lozadac@washpost.com

Carlos Lozada is The Washington Post's national security editor.


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