Ep. 21 Did the Financial Crisis Occur Because the Fed Was Too Timid?

6 February 2016     |     Tom Woods     |     17

Krugman evaluates the claims of market monetarists, who blame the Fed for the crisis because its policy was allegedly too timid. Krugman doesn’t agree (and on that he’s correct!), and he also finds it weird that “free-market” economists would say the Fed “caused” the crisis by not intervening. Isn’t not intervening what free-market economists are supposed to favor?

Krugman Blog Post

The Anti-Fed Two-Step” (January 29, 2016)

Books Mentioned

America’s Great Depression, by Murray N. Rothbard
Meltdown, by Tom Woods
The Politically Incorrect Guide to the Great Depression and the New Deal, by Bob Murphy
The Austrian Theory of the Trade Cycle and Other Essays, ed. Richard Ebeling

Video Mentioned

The video above is a selection from the full video below:

Murphy Column

Did “Tight” Fed Policy Cause the Financial Crisis?,” by Bob Murphy

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  • Dagny

    YAY! It’s here!

  • Lucien

    I’m pretty sure that according to the Solow Model when the government runs a budget deficit it causes a Trade deficit. Isn’t that the exact opposite of what they want? This is what we were taught in school. My professors were all Keynesians.

    • Ron H.

      The causation would be the other way around. A US trade deficit results in an equal capital account surplus in the foreign country with which there is a trade deficit, which surplus may be used to invest in assets in the US. including US government debt (treasuries).

      • Lucien

        That was not my point.

        • Ron H.

          What was your point?

          • Lucien

            I guess to me that would seem like a rather roundabout way to stimulate the economy at home. I could be wrong, but if it causes a capital account surplus in the other country doesn’t that mean that the foreign economy was stimulated and then after that took place it would stimulate the home economy? And if budget deficits persisted it would just increasingly stimulate the foreign economy. Again, I could be missing something.

          • Ron H.

            Only something that already exists can be borrowed. If there exists a capital surplus in a foreign country, say, China, it is because more goods and services has been exported to than imported from, say, the US (a very real example :)), that means the US has a bi-lateral trade deficit with China. The US government can (and does) borrow those US dollars from china in exchange for Treasuries, and uses the dollars to finance additional spending beyond that which could be funded by tax collections. This is a really poor way to attempt to “stimulate” the economy, as you can see from the current state of the economy after 8 years and trillions of dollars of stimulus.

            If you are unfamiliar with Austrian economics and Austrian Business Cycles, you have come to the right place. Bob & Tom are among the foremost experts. Check some of their other writings, books, and YouTube videos.

          • Lucien

            I am very familiar with Austrian Economics. But I was trying to see the problem from a Keynesian perspective. Here is a quote from Joe Salerno “For Mises and for the monetary approach, a chronic balance of payments deficit can only result from an inflationary monetary policy that continuously introduces excess money balances into the domestic economy via bank-credit expansion”. I am saying from a Keynesian view this would seem counterproductive. Because if demand stimulates the economy when you print money and it goes abroad it just stimulated another economy. Again, I am trying to see this from their point of view.

          • Ron H.

            Hmm…I think I understand what you mean now, and I don’t have an answer. The only thing I can see happening if country A continually inflates its currency while country B does not, (Salerno @ Mises Daily) is that consumers in A will see the price of imports from B rise, while consumers in B would see the price of exports from A fall. It’s likely less money would go abroad as import prices rise against domestic prices.

            In the old days this practice would have resulted in transfers of physical gold from the inflating country.

            Of course I reject the Keynesian notion that printing money stimulates “aggregate demand” in any meaningful or long term manner, so it’s difficult for me to think like a Keynesian or hold a Keynesian view.

          • Lucien

            It’s actually interesting if you look at Paul Krugman’s New Trade Theory, I feel like it is something that any Austrian would intuitively know. The Keynesians are far behind in international trade.

          • Ron H.

            Thanks for the link. It IS interesting. Imagine that insight being worth a Nobel prize! The main difference between this and Ricardo is the concept of national boundaries.

            Choice is Good. More choice is better. Economies of scale are good. Specialization is good. Larger countries have advantages over the same number of people living in many smaller countries because of fewer borders.

            Yeah, we already knew all that.

          • Lucien

            Only to a Princeton/MIT trained economist would common sense seem like a discovery. He probably believes in the Labor Theory of Value or something crazy like that as well. LOL.

  • Amber Day Sumner

    Hubby and I love the idea of a nerdy economics cruise! Unfortunately we have a no-fly policy as things currently stand and taking an extra two weeks off to drive from Alaska to Texas and back is just not in the cards. If 2017 departs from or ends in Anchorage, we’ll be the first to sign up!

    • caso0

      A very lucky man. Kudos to you two.

  • RobertRoddis

    I submit that the statists have the burden of proof to show that market fails and that violent intervention of both the Keynesian and monetarist variety is necessary. They cannot and will not do that. It is a mistake to let them off the hook regarding that proof.

    Back in 2009, Tom Woods gave a talk on the 1920 depression. During that talk, Tom mentioned that at the end of Wilson’s term, spending was slashed due to Wilson being incapacitated by a stroke. He jokingly called it “the stroke of luck” (which is also coincidently in the shownotes):


    Around the same time, Tom wrote a short piece about the 1920 depression that failed to mention Wilson at all. Daniel Kuehn jumped on that latter omission and wrote a paper (that costs $29) claiming to have refuted the Austrian analysis of 1920 due to the failure of Tom Woods to mention that most of the postwar spending cuts occurred under Wilson . Krugman cited Kuehn’s paper on his blog in January 2012:

    “Yesterday I mentioned that they’re still flogging the old line that Warren Harding proved that austerity works. I linked to my old demonstration that the 1921 economy was nowhere near the liquidity trap, and that there was substantial monetary easing, making comparisons to the current situation nonsense.

    Daniel Kuehn has more. it turns out that the Austrians/Austerians have their timing all wrong:

    Austerity proponents depend on the argument that substantial cuts to federal spending moved the economy to a recovery in 1921, but this understanding fails on multiple counts. The bulk of both fiscal and monetary austerity occurred immediately prior to the onset of the depression. Any austerity in policy decisions by the Wilson administration, the Harding administration or the Federal Reserve Board after the depression began were moderate compared with the considerable austerity measures taken by the Wilson administration and the Federal Reserve before the downturn. The evidence seems to suggest, even more clearly than in the case of the Great Depression, that postwar austerity may have even helped cause the 1920–21 depression. Subsequent monetary easing by the Federal Reserve occurred concurrently with the economic recovery, which itself was underway by the time Warren Harding took the oath of office.”


    Since we are forever being told by the statists that our AnCap “utopia” has never existed, I am always anxious for the statists to show with evidence when, where and how it failed (especially since it never existed). They never even try. Why do we need violent intervention in the market, including funny money, central banks and spending sprees if the market does not fail? How can what Kuehn has described as leading up to and causing the 1920 depression be deemed a failure of the market? We are talking about the slashing of wartime spending and inflation. He refers to it as “The austerity depression of 1920-21”:

    “2. The austerity depression of 1920–21 – During WorldWar I federal expenditures ballooned and although the new income tax was able to partially finance the war effort, most of the financing was done through federal borrowing and by the highly accommodating monetary policy of the Federal Reserve. The role of the Federal Reserve at this time was expressed unambiguously by the New York Federal Reserve Bank Governor Benjamin Strong, who told a Congressional committee in 1921 that ‘I feel that I, or the bank at least, was their [the Treasury’s] agent and servant in those matters’ and further added that the wartime inflation caused by the low interest rates maintained by the bank were ‘inevitable, unescapable, and necessary’ for prosecuting the war (Strong, 1930).”

    Three years ago, Daniel Kuehn conceded to me in comments to his blog that his “paper is consistent with the Rothbardian narrative”. I then asked him to prove that the market fails. I’ve never heard back.


    Sumner has never bothered to explain why we need such violent intervention either.


    The same problem appears in statist analysis of the 1929 depression because, to a certain extent, it was also the result of central monetary shenanigans leftover from WWI and not a failure of the market. The statists do not want to mention this.

    I think it is a mistake to ever fail to challenge the statists and make them prove that there is a market failure that requires their prescription of violent government interference to cure the problem that does not exist.

    • Luke Perkins

      Statists have proved markets fail… you libertarians are just blinded by your ideology.

      All you have to do is look at children going down into mines instead of starving to death, major panics stemming from free-market institutions like the Federal Reserve, poisoned water like in Flint Michigan, Fat Cats getting wealthier faster than everyone else via cronyism, and the destruction of the environment on lands next to private property…

      uh huh… uh huh… uh huh


      • RobertRoddis

        Wow. I guess you’re right. Nevermind 🙂