Here's my "methodology", Noah: Don't always use GDP as the context for everything.

When did the Fed tighten?

"the Federal Reserve caused the crisis by tightening monetary policy in 2008"

- Beckworth & Ponnuru

The blue line is made from two time series -- one old, one new. There is some overlap in the middle, which you can probably see. Combined, the two series show Federal Reserve holdings of Federal debt from 1953 to the most recent data.

This graph shows Fed holdings of Federal debt relative to GDP:

Graph #1: Fed Holdings of Federal Debt as a Percent of GDP

Things are different in recent years, what with the crisis and the recession and the quantitative easing. But from the mid-1950s to 2007 or so -- fifty years or more -- the blue line runs close to the 5% level. A bit low in the 1980s and, if anything, a bit high between 2000 and the crisis.

The blue line shows a general trend of increase since about 1980. Definite increase since 1990. If the line was high, money was loose. Money was loose in the years before the crisis. Looking at this graph, it is hard to see how tight money could have caused the crisis.

(Today's graphs do not show the sudden change in the demand for money that David Beckworth describes as "passive tightening" which occurred "in the second half of 2008" when "the natural interest rate is falling fast and the Fed fails to lower its target interest rate until October". I'm not looking at what happened in the second half of 2008. The crisis was hard upon us by then. I'm looking at the years before 2008, when the groundwork was laid for the crisis.)

In the decade before the crisis, the blue line rose from the old reliable 5% level to something over 5½%. This was money getting looser. Not tighter. That leaves us in an odd position: We can agree with David Beckworth that money must have got tight suddenly, in mid-2008. Or we can look elsewhere for tight money.

I'd love to agree with David Beckworth. But he is saying there was no early warning. He is saying no one could have predicted the crisis. That's funny. The whole point of economics is to understand the economy, to understand trends and tendencies, to know what's likely to happen and what's not. The whole point of economics is to seek the early warning. Beckworth has to throw that all away in order to make his argument.

I'd love to agree with David Beckworth. But he is wrong. His view is that the bottom fell out and the Fed did nothing "until October" and that's what caused the crisis. But the bottom falling out was the crisis.


Why do we look at Fed holdings of Federal debt relative to GDP? Maybe because GDP is the "size" of the economy?? But that's just a metaphor. What does GDP have to do with  the bills we pay? ... with the money we owe? ... with the accumulation of debt? Nothing. Nothing. Nothing.

On the next graph, the blue line is the same as in the graph above: Fed holdings relative to GDP. And I've added the red line, Fed holdings relative to accumulated public and private debt. Fed holdings relative to the money we owe:

Graph #2: Fed Holdings of Federal Debt as a Percent of GDP (blue)
Fed Holdings of Federal Debt as a Percent of TCMDO Debt (red)

The blue line shows Fed holdings relative to "the size of the economy". The red line shows Fed holdings relative to the money we need to pay our bills.

The blue line shows no hint of monetary tightness for two decades before the crisis. That's why Beckworth has to make up a story and pretend that the crisis, when it hit, was just tight money and the Fed would have time to respond to it. Nonsense. When the crisis hit, it was already a crisis.

Where can we look, for signs of tightness? Look at the red line. Look at Fed holdings relative to all the money we owe. Fed holdings have been in decline since about 1972. Hit a low in 1990 and caused a recession, went up a pixel or two, then continued to decline until it caused the crisis.

The red line shows tight money.

But we aren't even looking at money. We're looking at "Fed holdings". The next graph shows base money instead of Fed holdings. The blue line shows base money as a percent of GDP, similar to the blue line above. The red line shows it as a percent of TCMDO debt, like the red line above.

Graph #3: Monetary Base as a Percent of GDP (blue)
Monetary Base as a Percent of Total Debt (red)

The blue line shows increase from about 1980 to a few years before the crisis. The downtrend after 2000 could have had something to do with the crisis, possibly. But the low point of that post-2000 decline is no lower than in the latter 1990s. And things were good in the latter 1990s. So it is hard to see the post-2000 decline in the blue line as a monetary tightening that could have caused the crisis. But look at the red line.

The red line shows tightening from start to finish. Except in the early 1990s. (And the early 1990s is what made the latter 1990s so good, as I have shown repeatedly.)

The red line shows tightening from the mid-1990s to the crisis.It shows more rapid tightening after 2003. Could this have been the groundwork that set the stage for the crisis?

Of course.

It wasn't tightening in 2008 that caused the crisis. It was years of continuous tightening of money, relative to the money we need to pay our bills, that caused the crisis.


// "Methodology" in the title is a reference to Noah Smith's Occult Mysteries of the Heterodox