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  A Fed Economist Explains the Great Recession

  By James Annable | Aug 17, 2018

  Until his retirement early this year, Robert Hetzel was Senior Economist and Research Advisor at the Federal Reserve Bank of Richmond. He was one of the surprisingly few Fed economists attempting to make comprehensive sense out of the Great Recession. In his 2012 book, The Great Recession: Market Failure or Policy Failure, he identifies the two fundamentally different approaches to understanding macro instability that have dominated the economic literature, market-disorder versus monetary-disorder modeling. Hetzel, an advocate of relying on the mainstream market-centric general-equilibrium theory in Fed policymaking, makes the case for the monetary-disorder paradigm. His analysis provides an instructive contrast to the GEM Project’s generalized-exchange theory that provides a demonstrably superior explanation of the evidence, mechanics, and management of acute instability. (Chapter 6)

  Market-disorder view. From Hetzel (2012), p.2: “Adherents of the market-disorder view believe the sharp swings in expectations about the future from unfounded optimism to unfounded pessimism overwhelm the ability of offsetting changes in the real interest rate to stabilize economic activity. Those expectational swings arise independently of central bank actions and require discretion in the conduct of monetary policy. The failure of the price system to mitigate fluctuations in output provides an opening for the central bank and government to manage aggregate demand.”

  Monetary-disorder view. “Adherents of the monetary-disorder view believe that the real interest rate works well as a flywheel to stabilize fluctuations in aggregate demand around potential produced by real demand shocks. However, money creation and destruction can interfere with [markets’] self-equilibrating powers. The conduct of monetary policy by a rule providing a nominal anchor and allowing market forces to determine the real interest rate and real output makes expectations into a stabilizing force by causing the public to anticipate that shocks that produce divergences between real aggregate demand and potential output will be short-lived.” (Hetzel (2012), p.2)

  Generalized-exchange view. Two-venue modeling intuitively generalizes rational exchange from the marketplace to information-challenged workplaces. It degrades the dominating power of interest rates featured in...

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