On Wed, 6 Oct 1999, Brad De Long wrote:
> I see three periods:
>
> (i) one of successful counter-cyclical stabilization from 1948 to
> 1966 or so (as set out in Arthur Burns (1959), "Progress Toward
> Economic Stability")
This makes sense to me. But could you show me the flaw in Frederick Mishkin's reasoning? He claims (in his textbook _The Economics of Money, Banking and Financial Institutions_) that Fed policy was *pro*-cyclical during this period. He claims that, starting in 1952, the Fed targeted what they called "free reserves," which were excess reserves minus discount loans. He says the fed interpreted an increase in such free reserves as an easing of money market conditions, so they made open market sales to withdraw money from the system, and when such reserves when down, they made open market purchases to add it.
According to Mishkin, this was exactly backwards. His reasoning is as following. During an economic boom, interest rates rise. When interest rates rise, the opportunity cost of holding reserves rises, and excess reserves fall. Similarly, the incentive for banks to take out discount loans rises. When excess reserves fall and discount loans rise, naturally free reserves -- the first minus the second -- fall. The Fed would interpret this as a tightening of money market conditions and inject liquidity into the system right when there was a boom going on. And vice-versa during a recession. The free reserves would rise, and Fed would take that as a cue to withdraw money from the system.
According to Mishkin, this procyclical policy started when the Fed regained its freedom in 1952, and lasted until the end of the 1960's, when it was clear that it was making a mess of things. He also claims that all during this period, it made recessions deeper and booms bigger.
It's very suspicious the way this reasoning leaves out the whole world. But could you point out where it's flatly wrong in point of fact or logic? Then I'd feel much better.
Michael
__________________________________________________________________________ Michael Pollak................New York City..............mpollak at panix.com