George Selgin is a monetary theorist and historian. He is a senior affiliated scholar at the Mercatus Center at George Mason University and the previous director for the Centre of Monetary and Financial Alternatives at the Cato Institute. He is also the author of books such as False Dawn, Less than Zero, and Floored!
Interviewer: I’m joined today by George Selgin, who is a monetary theorist and historian. George is a senior affiliated scholar at the Mercatus Center at George Mason University and the previous director for the Center of Monetary and Financial Alternatives at the Cato Institute. He’s also the author of books such as False Dawn, Less Than Zero, and Floored. Thank you for taking the time to talk with us.
George Selgin: Oh, you’re very welcome.
Interviewer: So, my first question was about your recent release False Dawn, which gives an extensive treatment of the New Deal and the long road to recovery. One of my personal favorite discussions in the book was a discussion about FDR and Keynes, and you argue that FDR actually deviated in a lot of ways from what Keynesian recommendations at the time would have been. What would you have said that the main deviations of that policy was from the Keynesian recommendation?
George Selgin: Well, there were two kinds of deviations from Keynes’s recommendations, and let me just step back a bit and point out that there wasn’t a lot of interaction between Keynes and FDR. FDR mainly was rather inactive in this. Keynes, on the other hand, had written several letters to FDR, some of which were published in newspapers as well, so they were open letters. And then they had one meeting that was arranged, and it lasted only an hour. So the actual interaction between them was not great. Roosevelt had many other economic advisors who spent a lot more time trying to convince him to do what they wanted. Anyway, what Keynes wanted Roosevelt to do more of was deficit spending.
People think that FDR did a lot of deficit spending, and in some sense he did, relative to most previous administrations. But he didn’t really do large deficits—he didn’t really have deficits that carried a lot of fiscal stimulus oomph relative to the standards of today, certainly of what we think of as a good fiscal deficit jolt. And that’s because Roosevelt was a fiscal conservative. He really didn’t think deficits were a good thing in themselves, certainly didn’t think that they helped recovery by themselves. He was willing to tolerate deficits to support public relief programs, but otherwise he tried to limit them with taxes and all that. And Keynes thought, “No, you need a lot more deficit spending.” So on this score, the two departed.
But the other way they departed was that Roosevelt and the New Dealers did a lot of positive things that Keynes thought were either just bad ideas—like the National Recovery Administration trying to implement price and wage codes. Keynes, like most economists, thought that that effort was counterproductive. But other reforms and steps that the New Dealers took, Keynes didn’t think they were bad ideas in themselves or bad plans, but he did not think that a recession or deep depression was the right time for them. And he counseled Roosevelt to put off these reforms until the economy had recovered. Which, of course, isn’t what happened.
And so, for all of these reasons, I think it’s quite incorrect to treat the New Deal as a trial run of Keynesian countercyclical policy, because it was really quite far removed from what Keynes himself would have recommended.
Interviewer: I think it can be quite controversial now talking about countercyclical fiscal policy as a whole. And that many economists, like market monetarists, for instance—like Scott Sumner—have emphasized that fiscal policy isn’t really all that necessary anymore because we can overcome problems of the zero lower bound with our monetary policy. And in that way, there’s a question of what these new monetary tools actually have to tell us. Like figures like Larry Summers were kind of more sympathetic toward fiscal policy. But in that system where we have these new monetary tools, is there a role for fiscal policy at all?
George Selgin: Well, it’s a very good question. And I think the answer is that generally speaking, monetary stimulus, first of all, is what you should try to rely on because it’s less distorting and less wasteful. And second, except under very exceptional circumstances, it usually should suffice. Now, Keynes of course was arguing for fiscal stimulus in the 30s, was encouraging the government to spend more. But Keynes was not himself an opponent of monetary stimulus; he thought that could work as well.
The sad fact is that on monetary stimulus, the New Dealers—including Marriner Eccles, who was the Chairman of the Fed under Roosevelt—were even less inclined to take advantage of that. In fact, the Federal Reserve did not increase its interest-earning assets at all. That is, it didn’t actively buy securities or lend more to the banking system throughout the New Deal era—that is from 1933 to 1939, you can see that those items on its balance sheet are absolutely flat.
Now, there was monetary stimulus despite that. But it took shape because of factors outside of Federal Reserve policy, independent of that policy. And it consisted of vast amounts of gold that began to flow back into the US economy, especially as fear of war developed in Europe following Hitler’s rise to power. And so all this gold was flowing in and it was expanding the Fed’s balance sheet, but the Fed was passive in this. And the Treasury was passive. The Treasury was involved in giving gold certificates to the Fed in return for the actual gold it took possession of.
Far from welcoming this monetary stimulus, both the Treasury and the Fed took steps starting in 1936 to counter it. They were actually afraid that it was going to create an unsustainable boom. Now mind you, this is in the middle of the Great Depression! And so the Fed doubled reserve requirements, and at the same time the Treasury started to sterilize the gold inflows, which meant it didn’t give certificates to the Fed for the gold it purchased, so the Fed’s balance sheet didn’t grow anymore.
And economists generally agree that one or both of these factors caused the economy to slide into another depression in 1937, another very deep, steep recession that undid most of the gold flow-inspired gains from the previous two or three years. So it was altogether a very tragic story of a Great Depression in which neither fiscal nor monetary stimulus were allowed to help the economy recover. Which is quite different from what people would expect to see today. So we have a big lesson to learn from the New Dealers, but it’s mostly about what things you need to do that they didn’t do.
Interviewer: It reminds me of the circumstances over in Europe when Greece had their sovereign debt crisis. Your colleague David Beckworth, who you’ve appeared on Macro Musings plenty of times—he talked about the idea of austerity in the Eurozone and how the European Central Bank policy kind of affected those things. Do you think that there’s a problem there with the monetary unions and not having an independent central bank, because your fiscal policy isn’t as constrained to respond?
George Selgin: Well, of course there is a problem, but I think the real problem with the whole Eurozone setup was the failure of the Growth and Stability Pact. And this was certainly a factor in what happened in Greece. Because that pact wasn’t enforced, implicitly governments were borrowing—the Greek government in particular, but not just them—borrowing very, very heavily at extremely low rates. But ultimately, the creditors were relying on the fact that they would be bailed out. That the Growth and Stability Pact wouldn’t be enforced.
And in fact, early on the conditions of that pact were violated by some of the principal actors in the creation of the Eurozone. And once that happened, it was no longer credible—this commitment to not bail out participants that were having sovereign debt crises. And that was the end of that. So, it was a very different story, really. And also an example of, in this case, the fact that you needed certain restrictions on the Eurozone central banks to be credible.
In the United States in the Great Depression, the problem is not that the Fed’s hands were tied, or not tied enough, but simply that it did not do the things it could have done to help promote recovery. And remember, the Fed’s hands had been tied by the gold standard, but not after Roosevelt severed the dollar’s link to gold. At that point, the Fed’s capacity for engaging in quantitative easing, as we would call it today, was materially quite unlimited. But instead, the only quantitative easing that took place was the incidental easing that consisted of that gold flowing into the country.
Interviewer: And do you think that diagnosis of the European Central Bank, that they hadn’t done enough to prevent the collapse of the periphery regions—do you think that’s correct?
George Selgin: Well, it’s a different story because when you have a moral hazard from bailouts, the problem is if you do bail out, you are heading down the garden path. Because you’re going to repeat that cycle again and again and again. So the only way the Eurozone setup was going to work is if they not only didn’t bail out countries faced with sovereign debt crises, but they had to make a credible commitment that they weren’t going to do it. And at first, it seemed like they meant it.
But when countries started violating the terms of the commitment without having crises yet, that told creditors that this was just paper, and not something they had to really worry about. In other words, they implicitly thought, “Yeah, they’re going to bail ’em out.” And that was the end of that. So, very different situation. If the Federal Reserve had acted more aggressively in the 1930s, that would not have set up the stage for another crisis, because it wouldn’t have presented a moral hazard. It was just a very different sort of screw-up.
Interviewer: Moral hazard is a big conversation in the post-2008 sort of global financial era, and especially talking about the Great Recession. It’s significant. And your paper, L Street, raises a lot of those concerns. And one thing I found really insightful about that paper was your emphasis on the primary dealer system, and how that shaped the Federal Reserve’s ability to respond to the great financial crisis.
George Selgin: Yes, and this of course was all before the major overhaul of the Federal Reserve’s monetary framework that has happened since then. But what I argued in that paper was that really, what we needed—what we should have had—was a system where you didn’t need primary dealers first of all, because they’re absolutely unnecessary. Their existence traces back to the days of horses and buggies, and wanting to not have people have to, you know, runners moving between Wall Street and the various different financial firms in New York City.
But now everything’s done electronically. So in principle, everybody could be involved in these open market operations. You don’t have to have a select group. Now, that’s when they were still relying on open market operations for the day-to-day conduct of monetary policy, which has changed. Open market operations: buying and active Fed buying or selling of government securities.
In my proposal, you would just have a very open market for open market operations where basically the Fed is participating in a market where anybody—just about anybody who can buy and sell bonds—can take part in the open market operations through a competitive bidding process. And if you set it up right, the bidding process, you can make sure anybody who needs credit gets it directly, almost or close. And you can price the credit so that moral hazard is eliminated. And that was the basic idea.
And then you would not need a discount window. You wouldn’t need separate lender-of-last-resort activities. You would just have the conduct of monetary policy through open market operations being done in such a way that the same operations are making sure liquidity is being directed to firms that need it, because they’re all involved in bidding for these Federal Reserve funds that are being created. And so you don’t have to worry about loose links between the Fed creating money on one hand and firms that are suffering from a lack of liquidity on the other.
Interviewer: Yeah, lots of people think it’s a very just a sublime idea to just have a very liquid banking system. You avoid all the troubles of bank crises with it. But your book Floored kind of explores how there’s a bit of a hidden cost to that.
George Selgin: Yes, so now we’re talking about a different reform—not the one I recommended, but a different reform that was implemented by the Fed during the crisis of 2008 and subsequently, where they flooded the banks with reserves and then they paid them interest to hold reserves, which at first was counterproductive because at the time when they started paying interest, the last thing you needed was banks holding onto reserves. You needed them to lend more.
Anyway, they kept that system in place, and that’s what we have today. And the idea was that with all this liquidity sloshing around the economy—which has grown now to several trillion dollars worth of reserves—banks should never face liquidity problems. Well, we know from experience that no, that’s not true, partly because the reserves aren’t evenly distributed in the banking system. Several large banks have outsized shares of those reserves.
And also because liquidity regulations have changed in a way that makes it necessary for banks to hold a lot more liquidity if they’re to avoid penalties. So what has finally come out of all this is a situation that kind of resembles a person who gets addicted to a drug. So the banks have gotten addicted to what would once have been excess reserves, and they need more and more. And the more you give ’em, the more it takes for them to have their fix.
And there’s an economist, Bill Nelson, who’s written very eloquently about this, but it’s a kind of ratchet effect. And it helps explain why even though every round of quantitative easing we’ve had has added—ultimately trillions—to the available reserves, it has turned out not to be at all a simple matter to reverse those through quantitative tightening. Quantitative tightening much sooner than people expected starts having banks cry uncle, so to speak, and interest rates spiking. Because lo and behold, what had once been an incredible amount of unnecessary reserves now has become necessary. In the same way that a hefty amount of heroin can be just enough to keep you from having the DTs, or whatever the heroin equivalent of that is—I’m not a heroin expert! But withdrawal symptoms. So this is what the Fed has done.
I think it’s a terrible reform. Of course, I was a critic of it very early on, and nothing that has happened subsequently has changed my mind. On the contrary, the system has just grown into a bigger monster than ever, and I think it’ll keep growing.
Interviewer: And on the individual level, that’s led to a lot of thoughts about individual banks and how they expand. Which your paper about banks being intermediaries of loanable funds and your debates with Steve Keen on X have kind of talked about. What do you think the distinction is that post-Keynesians and other schools of thought are trying to make with this idea that credit is what drives savings originally?
George Selgin: There are a couple strands to their argument. One is claiming that because banks create money in making loans, that they’re not dependent on savings to support their lending. Now, this is with reference to ordinary commercial banks, not central banks. We all agree that central banks don’t need to borrow in order to lend. But I claim, and some other economists claim, that in fact commercial banks’ ability to lend depends on their ability to borrow from others. And this is another way of saying the same thing: that banks are intermediaries. That is, they are firms that lend to people, but only lend funds—mostly funds—that they have to borrow from other people. They have to get financed in order to finance.
Now, first of all, to respond to the post-Keynesian view: it is not true that because banks can create money, they don’t have to borrow in order to lend. Banks do create money. There’s no dispute about that, or there shouldn’t be. And it’s true that initially, when a bank makes a loan, it simply credits the borrower’s account with the stroke of a pen—or nowadays by hitting a few keys on a computer terminal. So, it’s creating the loan. Now, if that’s all there is to banking, it’s certainly a great business to be in!
But it isn’t all there is to it. The borrowers borrow to lend… just to spend. So they start writing checks or making other transfers from the credited account. In a competitive system, those transfers get received ultimately mostly by other banks. The other banks return the items—this is all happening nowadays with just electronic signals—but a signal is sent to the bank that made the loan that, “Okay, you’ve got to settle these.”
And the result of this is, other things equal, if a bank lends more, it had better have—be able to get a hold of—the underlying reserve medium with which to accomplish settlement with other banks. Now, they don’t have to have had that much of the reserve medium on hand when they made the loan. They can go get it after booking the loan. All they need to know is that they can get it for an interest rate that’s less than what the borrower’s rate—what he’s paying, or she. So they can do that afterwards.
Or they can speculate. They can count on the fact that at any time a certain amount of funds are flowing into the bank, and they can just be looking forward to using those funds. So they don’t have to be sitting on a pile of reserves and looking and saying, “How many reserves do we have? Oh, okay, we can lend that much.” That mechanical view of banks… of how banks intermediate is wrong. And the critics, including Keen, are quite right to treat those very mechanical, cartoonish textbook stories of how banks loan as being incorrect.
But then they go beyond to create… they go on to create their own completely incorrect view. I think it’s even more incorrect: that banks don’t have to worry about funding themselves at all and can just lend willy-nilly, as if every individual ordinary commercial bank had the same money creation and lending capacity as fiat money-issuing central banks do. And this is just not true. And to have a theory that essentially dismisses the idea that there’s a difference between what a central bank can do and what an ordinary bank can do is to have a very… a theory that’s going to give you a very poor understanding of how modern monetary systems actually work.
Now, I should say, it is true that banks that overdo it—and that might otherwise get in trouble because they’ve lent beyond available funding, that is, low-cost funding or profitable funding—can get emergency loans at the last minute from the Federal Reserve. But they don’t always. It’s not guaranteed. And it’s not supposed to be profitable, because the Fed charges penalty rates. So this is only a short-run… there may be these short-run exceptions where the banks don’t pay the highest possible price for their error, but they’re still paying a price, and they’re still ultimately discouraged from lending when they don’t have savings.
One final point about this, you wanna think about what this all boils down to in a more practical way. Think about a banking system where nobody wants to hold the banks’ IOUs. You show me a bank where the customers don’t want to lend to it by holding onto its IOUs, and I’ll show you a bank that goes out of business. It’s as simple as that. But according to the people who are my critics here, they shouldn’t have to worry about whether anybody wants to hold their IOUs or not. And well, they do.
Interviewer: I’ll wrap up on one final question. Over the course of your work, you’ve been at the forefront of shaping a lot of different debates in a lot of different ways that monetary officials and students alike now think about these different issues. But if I had to ask you, going back over the course to the very beginning of your career, what is one thing you wish you’d argued differently?
George Selgin: Ooh. I can think of a lot of little things that I would argue differently now. But I think that a better answer to the question would be that I wish that I had made clear what the objectives of some of my early research were. Particularly the free banking research. Because the idea developed, and I take some of the blame for it, that to be writing about free banking and how it could work and how it did work historically was the same thing as advocating a free banking system. That is, as if it was all about saying, “Let’s abolish the Fed and put this kind of arrangement in place.”
But it isn’t about that. It could be about that. You could certainly contemplate that for whatever good it’ll do you, because it’s a very, let’s say, unlikely prospect. But that’s okay, economists and others should talk about these things. But what I didn’t emphasize enough is that we can learn a lot from free banking theory about how we can improve our monetary and banking systems without having, you know, without being able to go whole hog into trying to actually make them into ideal free banking systems.
I wish I had emphasized that more, because the reality is, you know, that you often cannot have the full Monty. You’ve got to settle for marginal reforms. But free banking theory and history can teach us a lot about what kinds of reforms we should be aiming for, and which ones will do the most good. And it also helps to teach us a lot about how bad bank regulations can do a lot of harm when they’re ill-designed. And that’s something that too many people don’t get.
We usually think of regulation as something that you do to fix a problem. But regulation in the history of banking is something that has often been a source of problems, and often hasn’t fixed any problem at all, but was done to please special interests or something like that. So these are the things I would have emphasized more.
Interviewer: That’s a fantastic response. Thank you so much for your time.
George Selgin: Oh, you’re welcome very much.
