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  What Stabilized the Economy in 2009

  By James Annable | Sep 21, 2018

   

  Last week took a critical look at Andrew Ross Sorkin’s underdeveloped take on the macrodynamics of the Great Recession. What follows, originally published on April 8, 2016, looks at what actually worked in containing the 2008-09 extreme instability. Hint: It is not financial reregulation or any other attempt to prevent financial disruptions. As demonstrated in the GEM Project, logic and history indicate that crisis-prevention strategies are not sufficiently reliable to thwart future episodes of acute instability.

  This post examines, with admiration, the massive Federal Reserve effort to use its balance sheet to counterbalance mounting rational inaction of investors/lenders in the context of collapsing asset markets. Such inaction was the engine of the powerful contraction of nominal demand that was overwhelming automatic stabilizers and the central-bank purchases of short-term Treasury debt. The Fed’s goal in becoming the buyer and guarantor of last resort was designed to revive the recycling of saving into spending and reverse downward spiraling total spending and its associated huge losses of jobs, production, wage income, profits, and wealth. In so doing, the central bank critically demonstrated both its ability and will to deliver on its real-side objective of trend high employment and thereby prevent 1930s-class depression.

  The crisis. Asset markets quickly tanked after the bankruptcy filing by Lehman Brothers on Monday, September 15, 2008. During the first post-Lehman week, the bleak mood was punctuated by the Fed’s bailout of the trillion-dollar insurance giant AIG and the “breaking the buck” by the Reserve Primary Fund, a $67 billion money-market mutual fund hit by a wave of withdrawal requests. The Fed understood that Reserve-Fund busted-buck shock, if unchecked, presaged the failure of the $3.8 trillion MMMF industry.

  Bernanke and his inner circle recognized the making of, in GEM Project terminology, a nonstationary collapse in total spending that threatened depression. (Chapter 5) He adopted a “kitchen-sink” strategy. He instructed his advisors to think outside the box with respect to the Fed balance sheet, requesting everything they...

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