Science Is Prediction: Back-Testing the Market Monetarist-Endorsed Ted Cruz Explanation for the 2008 Crash
(Please don’t lecture me on the post title: I am making a wisecrack related to Dan’s very useful advice on a previous post.)
Recently Ted Cruz was grilling Janet Yellen. So far, so good. But then he said:
Senator Cruz: In the summer of 2008, responding to rising consumer prices, the Federal Reserve told markets that it was shifting to a tighter monetary policy. This in turn set off a scramble for cash, which caused the dollar to soar, asset prices to collapse, and CPI to fall below zero, which set the stage for the crisis. In his recent memoir, former Chairman Ben Bernanke says that the decision not to ease monetary policy at the September 2008 FOMC meeting was “In retrospect certainly a mistake.” Do you agree with Chairman Bernanke that the Fed should have eased in September of 2008 or earlier?
Scott Sumner and David Beckworth were both pleased with this line of questioning, and Scott also linked with approval to a Washington Examiner article saying Cruz’s questioning reflected Market Monetarist influence.
Now obviously, Scott and David are trained economists, and experts in Market Monetarism, so they would’ve been more nuanced if they had had the opportunity to grill Yellen. But if you read their commentary, I don’t see anything except a high-five for Cruz in this exchange. (They of course disavow his earlier support for the gold standard.)
All right then, with that background, to the point of my current post: I am wondering what kind of statement you guys think the Fed had to issue back in “the summer of 2008” that ultimately caused the financial crisis. Go look at Cruz’s statement above; he is definitely saying that the chain of events was that the Fed told markets something, and then this caused dominoes to start falling that ultimately led to the crisis in the fall.
In the comments (e.g. here) at various places where Cruz’s questioning was being discussed, I asked people for a link to the actual Fed statement in the summer of 2008 that Cruz had in mind. The only answer I saw (maybe someone answered after I stopped checking) was Scott himself, who said:
SCOTT SUMNER, EXPLAINING WHAT THE FED STATEMENT IN THE SUMMER OF 2008 WAS: “Bob, I’d guess he’s responding to Fed statements that they were increasingly worried about inflation, and likely to tighten in the future. (Which of course they did.)”
OK so now, without looking, I would like you guys–especially if you are fans of Sumner–to type out your guess as to what the Fed’s statement(s) in the summer of 2008 probably sounded like, to explain how the Ted Cruz / Market Monetarist theory is plausible, in that it was not underlying “real forces” but in fact the Fed pushing expectations through its statements/actions in the summer of 2008 that caused the global financial crisis a few months later.
So please, type out your guesses in the comments of this post. In a few days I’ll paste what the Fed actually said. But NO CHEATING: You are on your own intellectual honor, I want you to type out the type of Fed statement in the summer of 2008 that you think plausibly explains the global financial crisis.
One last thing: Even after you type out your own guess, and then if curiosity is killing you and you go look it up, please don’t spoil it for others by posting it here. Let’s keep this comment section reserved just for people’s guesses. And again, I want to stress that I’m hoping for fans of Market Monetarism to chime in here. I want you to tell me, off the top of your head (that’s important for this exercise), what type of thing the Fed said in the summer of 2008 that you think is a much better explanation for the subsequent financial crisis than the housing bubble or some other “real factor.”