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Two Big Intellectual Victories for Ben Bernanke

Passing unnoticed in all the chaos is that the current financial crisis is giving Ben Bernanke two great intellectual victories.

There have long been several live issues in the study of the Great Depression. One is the question of whether it would have been enough to stop the Depression for the Federal Reserve to simply have injected so much liquidity into the economy to keep the money stock from falling. Milton Friedman said yes. Others muttered about "pushing on a string" and said no. Ben Bernanke pointed out that the credit channel depended not on the economy's liquidity but on the banking sector's capital--and that if the credit channel were important than all the liquidity policies in the world wouldn't help unless they could somehow by accident recapitalize the banking sector.

The course of events this year is a major win for Ben Bernanke.

A second live issue is whether--as Larry Summers and I have argued--it was expectations of further deflation that were key to discouraging private investment spending, or whether it was the legacy of past deflation in freezing up the banking system that was the key to the collapse of private investment, as Bernanke argued. Here again I think the experience of this year is convincing evidence that Bernanke was right.

Of course, at this stage he would rather that he had been wrong in his focus on the strength of the credit channel...