Bernanke says policymakers prevented 'cataclysm' worse than Great Depression

By Neil Irwin
Friday, April 9, 2010

The world's economic policymakers successfully learned the lessons of the Great Depression, helping to avert a horrendous economic outcome from the 2008 financial crisis, Federal Reserve Chairman Ben S. Bernanke said Thursday.

In a speech that drew on his academic specialty -- the economic history of the 1930s -- Bernanke sought to give some historical perspective to efforts by the Fed and other policymakers to combat the 21st century economic downturn.

During the 1930s, policymakers' responses to the financial collapse "ran the gamut from passivity to timidity," standing by as banks failed by the hundreds. "They were insufficiently willing to challenge the orthodoxies of their day," Bernanke said in an address after receiving an award from the Center for the Study of the Presidency and Congress.

His historical argument was mounted as a defense of the forceful -- and frequently controversial -- actions that the Fed took under his leadership to combat the crisis. Bernanke said that had he and other economic policymakers not moved so aggressively, the downturn could have been even worse than the Depression, when unemployment was 25 percent.

"In the current episode, in contrast to the 1930s, policymakers around the world worked assiduously to stabilize the financial system," he said. "As a result, although the economic consequences of the financial crisis have been painfully severe, the world was spared an even worse cataclysm that could have rivaled or surpassed the Great Depression."

In his speech, Bernanke drew parallels between the actions the Fed took and the "bold experimentation" that followed the inauguration of Franklin D. Roosevelt.

For example, in 1933 the Roosevelt administration shut down banks in a "national bank holiday," sending in examiners to evaluate their finances, then declaring those that were allowed to reopen as being sound. Bernanke argued that such policy is not that different from the Fed's "stress tests" of major banks last year, in which bank examiners analyzed the finances of the largest banks and ordered them to raise more money if they appeared unable to survive in a worse-than-expected economy.

"Critics had warned that the stress test could backfire, but as it turned out, the release of the results last May helped restore confidence in banks, and many institutions have since been able to raise capital from investors and repay the capital the government had injected," he said.

Separately, Fed Vice Chairman Donald L. Kohn said Thursday that a "moderate" economic recovery is underway and that the uncertainty around the economy has dissipated in recent months.

"The economy appears to be moving in the right direction, though not as quickly as we all would like," Kohn said in a speech in San Francisco. The fact that conditions have evolved as he and other forecasters had expected last fall "suggests that the future may, just may, be a bit less uncertain than before," he said.

Noting the nation's continued high unemployment rate, Kohn said that given subdued inflation pressures, the Fed should keep its policy of ultra-low interest rates in place for some time to boost hiring and economic activity.

He added, however, that interest rate hikes will come before the U.S. unemployment rate has dropped to normal levels, given the lags in the working of monetary policy.

The Fed will "want to be sure that we haven't left highly accommodative policy in place so long that economic and financial conditions become conducive to future inflation," Kohn said. Given that monetary policy takes effect slowly, "that means we will not be able to wait until the unemployment rate is down close to its long-term level."

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