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Similar, had Benjamin Strong, the über- competent governor of the Federal Reserve Bank of New York, not passed away in 1928, or Jean- Claude Trichet not become president of the European Central Bank as the result of a Franco- German bargain in 1999, the conduct of monetary policy might have been different. Specifically, it might have been better.

But working in the other direction is the fact that government can step up. It can lend when banks don’t. It can substitute its spending for that of households and firms. It can provide liquidity without risking inflation given the slack in the economy. It can run budget deficits without creating debt problems, given the low interest rates prevailing in subdued economic conditions.


And if the Fed was reluctant to do more, the ECB was anxious to do less. In 2010 it prematurely concluded that recovery was at hand and started phasing out its nonstandard measures. In the spring and summer of 2011 it raised interest rates twice. Anyone seeking to understand why the European economy failed to recover and instead dipped a second time need look no further.


The fear was nowhere deeper than in Germany, given memories of hyperinflation in 1923. German fear now translated into European policy, given the Bundesbank- like structure of the ECB and the desire of its French president, Jean- Claude Trichet, to demonstrate that he was as dedicated an inflation fighter as any German. The United States did not experience hyperinflation in the 1920s, nor at any other time, but this did not prevent overwrought commentators from warning that Weimar was right around the corner. The lessons of the 1930s— that when the economy is in near- depression conditions with interest rates at zero and ample excess capacity, the central bank can expand its balance sheet without igniting inflation— were lost from view. Sophisticated central bankers, like Chairman Bernanke and at least some of his colleagues on the Federal Open Market Committee, knew better. But there is no doubt they were influenced by the criticism. The more hysterical the commentary, the more loudly Congress accused the Fed of debasing the currency,


Much may have been learned about the case for fiscal stimulus from John Maynard Keynes and other scholars whose work was stimulated by the Great Depression, but equally much was forgotten. Where Keynes relied mainly on narrative methods, his followers used mathematics to verify their intuitions. Eventually those mathematics took on a life of their own. Latter- day academics embraced models of representative, rational, forward- looking agents in part for their tractability, in part for their elegance. In models of rational agents efficiently maximizing everything, little can go wrong unless government makes it go wrong. This modeling mind- set pointed to government meddling as the cause of the crisis and slow recovery alike. Interference by the government- sponsored entities Freddie Mac and Fannie Mae had been responsible for the excesses in the mortgage market that precipitated the crisis, just as uncertainty about government policy was the explanation for the slow recovery.