A (Brief) Critical Review of “This Time is Different”

Eastern bloc economists Carmen Reinhart, she of the University of Maryland, and Kenneth Rogoff, he of Harvard, have gotten rave reviews for This Time is Different: Eight Centuries of Financial Folly, published in 2009 by Princeton University Press.

I started reading it today, now that the book is out in paperback. It didn’t take long for my blood to boil.

First, the book’s early pages repeatedly refer to the “financial crisis of the late 2000s” (my emphasis). Unless the authors are forecasting events to come, say in 2099, either they or their PUP copy-editor was asleep at the switch. Did not the crisis at hand happen in the early 2000s? (Sorry, I am a journal editor and thus notice these things.)

Second, the authors call the current global recession and the anemic recovery from it the “Second Great Contraction”. In doing so, they draw an analogy to the title of a famous chapter in Milton Friedman and Anna Schwartz’s monumental Monetary History of the United States, 1860–1960, also published at Princeton, NJ, in 1963. Reinhart and Rogoff claim, in footnote 7, p. 393, that Friedman and Schwartz coined the term “Great Contraction” in “depicting the 1930’s [sic: 1930s’] Great Depression.”

They did nothing of the sort: Friedman and Schwartz’s “Great Contraction” referred to the Fed’s purposeful engineering of a sharp reduction in the money supply, beginning in 1928, meant to curb rampant appreciation in asset prices resulting from earlier monetary policies that had been “too loose”. That money supply collapse triggered the Great Depression, but, except for the “Roosevelt Recession” of 1937–1938 (when the Fed again erred by raising member banks’ required reserve ratios dramatically) did not deepen or prolong it. We now know that FDR’s counterproductive fiscal and regulatory policy initiatives proximately were responsible for the following decade or more of economic malaise.

Third, Reinhart and Rogoff studiously ignore Austrian theories of the business cycle, which emphasize the roles played by alternating periods of (bank) credit expansion and bust. “Quantitative easing” (money supply expansion) lowers interest rates and creates incentives for businesses to undertake fixed capital investments that, when the next crunch eventually happens, turn out in hindsight to have been ill-advised, demanding painful adjustments. The Great Depression, consequently was, in Joseph Schumpeter’s words, “the wreckage of false expectations”, seduced by artificial governmental economic stimulus.

Ben Bernanke’s recent attempt to raise from the dead “Operation Twist” of the early 1960s, intending to reduce long-term interest rates in order to stimulate business investment and home-buying, is a case in point. Fortunately, though, the Fed’s attempt to “twist” the yield curve will be no more successful now than it was then.

Reinhart and Rogoff have assembled an impressive array of historical statistics on banking crises, sovereign debt default and price inflation, all of which teach the valuable lesson that this time is not different. Governmental debt indeed is worrisome. But business and consumer debt is not, unless its accumulation is promoted by public policies rewarding lenders for granting loans to people who cannot be expected to repay and protecting creditors implicitly or explicitly against downside risk.

If you are looking for an explanation as to why these episodes of boom and bust, borrowing and default, price stability and inflation recur repeatedly, you will not find it in This Time is Different. The parochial interests of politicians and bureaucrats, including the chairpersons of domestic central banks and international organizations, such as the IMF, are not modeled, nor are those of national sovereigns or other fiscal policy authorities.

Mistakes were made recently in not allowing US financial institutions to fail. The same mistake should not be made nowadays with respect to Greece, Spain, Portugal and other sovereign debtors, including the United States. After all, the main lesson of This Time is Different is that today’s multiple crises are not different from anything experienced in the past. Default has happened many times before – and no one has been killed in consequence. As a matter of fact, although the pain of getting the globe’s fiscal house in order would be harder and more widely felt. it would be shorter lived if national budgets were forced by bankruptcy into fiscal order.

Barack Obama, call your office!