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Dean Baker

Dean Baker is co-director of the Center for Economic and Policy Research

November 29th, 2009 4:05 PM

Bernanke Forgot About His Role In Causing the Great Recession

Ben Bernanke's column in the Washington Post has to be absolutely infuriating to anyone old enough to remember the events of 2008. In this column, Bernanke lectures the public about the need for the Federal Reserve Board to preserve its independence from Congress, explaining that:

"The government's actions to avoid financial collapse last fall -- as distasteful and unfair as some undoubtedly were -- were unfortunately necessary to prevent a global economic catastrophe that could have rivaled the Great Depression in length and severity, with profound consequences for our economy and society. (I know something about this, having spent my career prior to public service studying these issues.) My colleagues at the Federal Reserve and I were determined not to allow that to happen."

It's nice to talk about the Fed's response to this crisis, but Mr. Bernanke's studies apparently did not tell him the obvious, that allowing an $8 trillion housing bubble to grow unchecked would lead to an economic disaster like what we are now experiencing. He and his colleagues at the Federal Reserve Board either could not see, or did not care about, this huge bubble. As a result, Ben Bernanke has been running around for much of the last year and a half telling us about his knowledge of the Great Depression.

It is worth quickly explaining why a collapsed housing bubble leads to a recession, since the policy people responsible for this disaster have done so much to try to obscure the obvious.

In the years prior to its collapse, the bubble was driving the economy. Bubble-inflated house prices created an unprecedented housing boom. Residential construction peaked at more than 6.0 percentage points of GDP in 2005.

The $8 trillion in bubble housing wealth led to a consumption boom also. This is the well known housing wealth effect that holds that one dollars of additional bubble wealth will cause annual consumption to increase by 5-7 cents. The implication was that an $8 trillion bubble would push annual consumption up by between $400 billion and $560 billion.

When the bubble collapsed, residential construction fell through the floor as builders suddenly realized that we had an enormous housing glut. The drop in annual construction was more than 3 percentage points of GDP, or more than $500 billion. At the same time, when the bubble driven housing wealth disappeared, we lost close to $500 billion in annual consumption.

We had further losses in demand associated with the bursting of a bubble in non-residential real estate. In total, the loss in bubble-driven demand was well over $1 trillion a year. All of it an entirely predictable outcome of the collapse of a housing bubble.

The simple reality is that there is nothing in the Fed's bag of tricks that will allow it to easily replace over $1 trillion in annual demand. In short, the bubble guaranteed the economic disaster that we are now experiencing, end of story.

It is also amusing the Mr. Bernanke at one point turns to the "global consensus on the appropriate role of central banks." Perhaps Mr. Bernanke missed it, but this global consensus doesn't look very good right now. One of the poster children of the global consensus was Iceland. The country was applauded for its independent central bank and its strong record on inflation targeting.

The arrogance of this column is almost beyond belief. This man is incredibly lucky to still have his job at time when millions of other workers have lost theirs as a direct result of his incompetence. A serious news outlet would not have printed such a ridiculously self-serving piece without at least securing an opposing opinion. Of course, Bernanke's piece appeared in the Washington Post.

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