Introduction

In Lords of Finance: The Bankers who Broke the World, Liaquat Ahamed (2009) provides a graphic account of the ill-designed and uncoordinated response by central bankers, in the US and elsewhere, to the US stock market collapse of 1929. Prior to the bust, the US had enjoyed a substantial investment boom – with the real capital stock increasing by more than 3 per cent a year since 1925 – but the value of the stock market, as measured by Tobin’s q, had increased much faster, more than doubling over the same period (see Figure 4.1). Then, in two short years, the US stock market fell by more than 70 per cent and the capital stock began literally to contract. These were the years of the Great Depression, when the US banking system collapsed and unemployment grew to more than 20 per cent – leading Roosevelt to declare war on unemployment and Keynes to develop the theory of demand-determined output, published in 1930.

Faced with what Charles Bean (2009) describes as ‘The Great Panic’ following the collapse of Lehman Brothers in September 2008, the Federal Reserve, the ECB and the Bank of England were determined to avoid a repeat of the 1930s. The slogan – according to Wessel (2009) – was to do ‘whatever it takes’, be this slashing interest rates to almost zero, dishing out widespread loan guarantees, recapitalising major banks and conducting quantitative easing, with open market operations (QE) involving either long-term government debt and/or frozen money market assets. Central bank balance sheets ballooned sharply as never before – doubling in the US, tripling in the UK (see Figure 4.2) – and Treasury backing had to be sought for the quasi-fiscal nature of some of these operations. In the event, output did fall in the US and elsewhere, but there was no Great Depression.