83 - Jeffrey Rogers Hummel on Myths about the Fed and Interest Rates

Episode Summary

Executive Summary: Jeffrey Rogers Hummel argues that the Fed’s crisis response in 2007–09 reflected a Bernanke-style focus on financial intermediation rather than Friedman’s money-supply view of crises. He says sterilized lending, interest on reserves, and QE turned the Fed into a financial central planner while obscuring how market interest rates, not the Fed, drive real rates. He also criticizes efforts to eliminate cash as both economically and politically harmful.

Main Topics: Hummel’s path into economics and monetary history (Priority: 2/5): Hummel explains how training in history, exposure to Austrian and monetarist thinkers, and work with economists shaped his dual focus on history and economics. Bernanke vs. Friedman on the Great Depression and the 2008 crisis (Priority: 5/5): The discussion contrasts Friedman’s view of the Great Depression as a money-supply collapse with Bernanke’s emphasis on broken financial intermediation and how that shaped Fed policy in 2007–09. Sterilized lending and the Fed’s pre-QE crisis response (Priority: 5/5): Hummel argues the Fed’s initial emergency lending to banks was sterilized through Treasury sales, leaving the monetary base essentially unchanged despite rising financial stress. Interest on reserves, QE, and the Fed as a financial intermediary (Priority: 4/5): He contends that paying interest on reserves and large-scale asset purchases expanded the Fed into a market allocator of credit, weakening broad monetary transmission and complicating inflation control. The myth of Fed control over interest rates (Priority: 4/5): Hummel challenges the popular claim that the Fed sets rates, arguing market forces determine real interest rates and that central banks mainly influence nominal rates via inflation over the long run. The case against abolishing cash (Priority: 4/5): He critiques Rogoff’s proposal to phase out cash, arguing it would harm productive underground activity, reduce a check on government power, and impose unnecessary costs on users of physical currency. Negative interest rates and the effective lower bound (Priority: 4/5): Hummel rejects the idea that eliminating cash is needed to enable negative rates, arguing monetary expansion—not rate manipulation—is the better solution when policy is constrained.

Key Arguments: Friedman’s interpretation of the Great Depression as a medium-of-exchange/money-supply collapse is more policy-relevant than Bernanke’s financial-intermediation framing because it implies broad monetary expansion rather than targeted bailouts. From August 2007 through late 2008, the Fed largely sterilized its emergency lending by selling Treasuries, so it expanded credit to institutions without meaningfully expanding the monetary base. Bernanke’s inflation-targeting mindset made the Fed overly cautious during a liquidity crisis, especially amid commodity-price spikes that looked like supply shocks rather than sustained inflation. Interest on reserves helped the Fed manage higher reserves but also turned the central bank into a major allocator of credit and contributed to a collapse in the money multiplier. The Fed has limited short-run influence over real interest rates; prolonged low rates generally reflect weak market conditions or low inflation, not simply central-bank control. QE and large balance-sheet policies may affect asset allocation and yields, but they are a poor substitute for broader money growth when the goal is macroeconomic stimulus. Eliminating cash would likely push legitimate underground activity into the tax net, but Hummel says this requires a full welfare analysis and ignores the social role of the underground economy as a check on state power. Negative interest rates are not a compelling reason to abolish cash because a central bank can expand the money supply through open market operations or other asset purchases without removing paper currency. Rogoff’s proposal appears strongest where cash use is least problematic and weakest where cash serves as a crucial monetary and social backstop, especially in poorer or more corrupt economies.

Data Points: Great Depression money supply decline: M2 fell by about one-third; M1 fell by about 25% - Used to support Friedman’s view that monetary contraction worsened the Depression. Fed crisis-response start: August 2007 - Hummel says the Bernanke Fed’s emergency response began when repo and asset-backed commercial paper markets showed stress. Term Auction Facility launch: December 2007 - Introduced to encourage more bank borrowing from the Fed. QE start: October 2008 - Marks the end of the sterilized-lending phase and the start of balance-sheet expansion. Fed funds futures expectation: 3.5% from 2% over the next year - A June 2008 market signal cited to show expectations of higher rates amid a weakening economy. Inflation target: 2% - Hummel argues U.S. inflation undershot this target even after the crisis, showing limits of inflation targeting. Interest on excess reserves payments: About $6 billion in 2015; about $12 billion in 2016 - Used to illustrate how payments to banks rose as rates increased. Fed balance sheet: About $4.5 trillion - Referenced in discussing the Fed as a very large fixed-income intermediary. Underground economy size in U.S.: Around 10% of GDP - Hummel cites estimates of how much measured GDP could rise if underground activity were counted. Underground economy size in Italy: Close to 25% of GDP - Example showing the importance of cash and informal activity in some developed economies. Cash held abroad: Perhaps 40% to 50% of U.S. dollar bills - Rogoff’s own concession that many U.S. notes are used overseas. Interest-rate floor: Slightly below zero - Hummel notes interest rates can go a bit negative, but not indefinitely because cash becomes attractive.

Pivotal Quotes: "We did it. We're very sorry. But thanks to you, we won't do it again." — Ben Bernanke: Bernanke’s remark at Milton Friedman’s 90th birthday celebration, invoked to frame the Great Depression debate. "the Federal Reserve as a U.S. economy central planner" — Jeffrey Rogers Hummel: Hummel’s characterization of the Fed after it moved from sterilized lending into QE and interest-on-reserves operations. "I don't think interest rates are the important indicator of what's happening with monetary policy." — Jeffrey Rogers Hummel: Core statement in his critique of using rates rather than money supply as the policy guide.

Implications: Listeners should see crisis policy through the lens of money, not just rates or targeted bailouts. Hummel warns that large-balance-sheet central banking and cash abolition both expand state power, distort allocation, and may weaken long-run monetary discipline.