Money Sage (archive)

We have attempted to think through the FED's amazingly inept performance since the sub-prime crisis broke back in the summer, but we remain dissatisfied with our explanations to ourself. Consequently, we have decided to set about seeking the answer to this riddle via an entirely HYPOTHETICAL exercise.
We are going to give the matter over to a detective. Here is our imaginary dialogue of the future:

Moneysage: We cannot understand it. Who could possibly be responsible for this bad economic downturn? It could have been avoided with well-thought out behavior.

Detective: A crime has been committed. Whenever a crime is committed, a detective looks for 3 things:
(1)Means
(2)Motive
(3)Opportunity

Moneysage: But who had these things?

Detective: Well, who had the means?

Moneysage: The FED

Detective: Did anyone else have the means?

Moneysage: No

Detective: Who had the Motive?

Moneysage: Why, no one. Who could possibly want a recession?

Detective: Who would benefit from a recession?

Moneysage: Well, let's see. It would benefit...CREDITORS! These folk would be paid interest in increasingly valuable dollars as prices fell during the recession. And the value of their loans and bonds would rise!

Detective: Very good, Moneysage. But let me ask you this: did creditors have the means to cause a recession?

Moneysage: Well...no.

Detective: Who had the means?

Moneysage: Only the FED.

Detective: Would the FED benefit from a recession?

Moneysage: As I think about it, they might not benefit directly, but they might THINK they would benefit. Also, they might benefit psychologically and in terms of their status among their peers. These folks have a monomania about inflation; their chief aim in life is to destroy inflation, almost regardless of the "short-term" impact on the economy. If they lick inflation, the economics profession and the bankers will hail them as Saviors. And they are convinced that by destroying inflation they will lay the groundwork for FUTURE prosperity. So, yes, they would benefit a lot.

Detective: What about opportunity? Did they have the opportunity?

Moneysage: Certainly. They set interest rates and control the amount of liquidity that finds its way into the banking system and into the economy. They can cause recession or inflation by changing the supply of liquidity and the price of money.

Detective: Case solved. You have your culprit.