Monday, 16 October 2017


Paul Krugman Bashes the Fed…

Posted by
May 23, 2012
in Blog

…just not on purpose.


In a few recent blog posts, Paul Krugman used bar graphs and tables to (allegedly) prove the superiority of his views over those of the Austrians. Yet, as I’ll show in this article, I can use Krugman’s own data to demonstrate the exact opposite.

Krugman on the Fed and Banking Panics

Perhaps spurred by his Bloomberg debate with Ron Paul, Krugman posted the following regarding financial panics and the US central bank:

There’s a very widespread belief on the right that banking crises only happen because either the Fed or Barney Frank cause them; go back to a gold standard, and there would be no need for financial regulation or anything like that.

This is, of course, nonsense; Walter Bagehot knew all about financial crises, which have been a constant feature of modern economies since at least the early 19th century. Just to drive the point home, I thought it might be worth posting Gary Gorton’s chartDownload PDF (pdf) of “panics” before the Fed went into operation:

Figure 1

Panics will happen; the question is how they are contained. (emphasis added)

Now although Krugman doesn’t explicitly say “Ron Paul” or “Austrian economists,” I think he has to have them in mind here. After all, before the Austrians rose in popularity, hardly anybody talked about the gold standard, let alone abolishing the central bank. It was the Austrians, and most notably Ron Paul, who put those ideas back into the limelight so that Paul Krugman feels the need to address the issue.

In that light, Krugman is simply making stuff up when he says such people think banking panics never happened before the Fed. Murray Rothbard’s doctoral dissertation was The Panic of 1819, and Rothbard also wrote on the history of the Fed, so I’m pretty sure he wouldn’t be shocked by Krugman’s table.

But besides the cheap debating ploy — setting up his opponents as believing something obviously ridiculous — Krugman leaves open the door to his own demise in his final sentence, after the chart, when he writes, “Panics will happen; the question is how they are contained.”

Fortunately, Krugman himself provides the answer in a follow-up post on the very same day. In this new post he writes,

A followup on this post. We had frequent banking panics before there was a Fed; how bad were they?

Well, Christy Romer has an old paperDownload PDF on long-run volatility, in which she created a metric: percentage-point months of industrial production lost until previous peak was regained:

Figure 2

So some of those pre-Fed panics were worse than the big slumps of 1974 and 1981, although far short of Great Depression stuff.

By my estimate, the current number using industrial production data is 455; it will get a bit bigger but not much if the recovery continues.

So we’re doing worse than after, say, the Panic of 1907 — but not that much worse.

How do you like that? By Krugman’s own admission, the two worst panics occurred after the Fed was formed. And if we take Romer’s numbers from the table above, and plug in a decline of 455 for the most recent recession (which Krugman himself says will be an understatement), we get that the average “output loss” (measured in the units Romer defines in the chart) during recessions from the pre-Fed era was 158.1, while in the post-Fed era it was 356.4.

Does everyone see the significance of this? Krugman himself said that panics will always happen, and the question is how they are contained. Using Krugman’s own source, we find that the establishment of the Fed generated (a) the two worst panics in US history and (b) a string of panics that were on average more than twice as bad as the average panic from the pre-Fed era.

Steve Horwitz does a good job explaining why Krugman’s understanding of US banking history is flawed, because we didn’t have laissez-faire banking in the late 1800s. But we don’t even have to rely on such explanations for the matter at hand. Remember, these data weren’t pulled from Krugman after a session of waterboarding. He volunteered them as if they were somehow supposed to embarrass the critics of the Fed. What would the numbers have to look like, for Krugman to have admitted, “Hmm, it seems like for once, empirical reality has turned against my Keynesian nostrums”? Would the post-Fed panics have to be three times as bad?

One last thing before I leave this topic, because I just want to make sure everyone sees what a rhetorical illusionist Krugman is. After he ballparks the current number (using Romer’s metric for output loss) at 455, he writes, “So we’re doing worse than after, say, the Panic of 1907 — but not that much worse.”

That word “say” in his quotation makes it sound as if Krugman threw a dart at Romer’s left column, and picked the panic that happened to come up. But no, the Panic of 1907 is the worst one of the pre-Fed era shown in Romer’s list. With as much justification, Krugman could have written the following summation instead: “So the second-worst recession of the Fed era — which we’re experiencing right now even though the guy I said there’s nobody I’d rather be Fed chief has been at the helm the whole time — is already worse than the absolute worst episode from the pre-Fed era. But hey, as long as this recovery continues — and I often warn that we are on the verge of disaster if Republicans take over — we’re not doing that much worse. It’s not like right now we’re anywhere close to being as awful as under the Great Depression, which happened 20 years after the Fed was formed to prevent things like the Panic of 1907.” …

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