BIS: The Difference of Great Depression and the 2008 Crisis is Central Bank Inflationism

What’s the fundamental difference between the crisis of the Great Depression in 1931 and that of the US Mortgage crisis of 2008?

The Bank of International Settlement (BIS) gives an answer: central banking inflationism

Here’s the concluding remarks of William A Allen and Richhild Moessner from their recently published paper:

We have suggested a number of ways in which the financial crisis of 2008 was propagated internationally. We argue that the collateral squeeze in the United States, which became intense after the failure of Lehman Brothers created doubts about the stability of other financial companies in the United States, was an important propagator. The provision of large-scale swap lines by the Federal Reserve relieved many of the financial stresses in other countries that had followed Lehman Brothers’ failure. The unwinding of carry trades, particularly yen carry trades, is also likely to have transmitted market volatility to the countries that had been the destination of the carry trades when they were first put in place. It seems likely that, at the time of writing, there is still a large quantity of yen carry trades to be unwound.

In both crises, deposit outflows were not the only important sources of liquidity pressure on banks: in 1931, the central European acceptances of the London merchant banks were a serious problem, as, in 2008, were the liquidity commitments that commercial banks had provided to shadow banks. And in both crises, the behaviour of creditors towards debtors and the valuation of assets by creditors, were all very important. Flight to liquidity and safety was an important common feature of the crises of 1931 and 2008. In both episodes, the management of central banks’ international reserves appears to have had pro-cyclical effects.

However, there was a crucial difference, in that the supply of assets that were regarded as liquid and safe in 1931 was inelastic and became narrower with the passage of time, whereas in 2008, it could be, and was, expanded quickly in such as way as to contain the effects of the crisis. The understanding that the role of governments and central banks in a crisis is to enable such assets to be supplied was perhaps the most important lesson of 1931, and the experience of 2008 showed that it had been learned.

The difference has been Central Bank's asset-purchasing program or termed as credit easing policies a.k.a Quantitative Easing.

The BIS gets it.

The deflation camp based on premises of “aggregate demand” does not.

Perhaps a little more elaboration from the great Murray N. Rothbard who presciently wrote (What has Government Done To Our Money), [emphasis added]

But the central Bank, by pumping reserves into all the banks, can make sure that they can all expand together, and at a uniform rate. If all banks are expanding, then there is no redemption problem of one bank upon another, and each bank finds bank expansion of one bank upon another, and each bank finds that its clientele is really the whole country. In short, the limits on bank expansion are immeasurably widened, from the clientele of each bank to that of the whole banking system. Of course, this means that no bank can expand further than the Central Bank desires. Thus, the government has finally achieved the power to control and direct the inflation of the banking system.

In addition to removing the checks on inflation, the act of establishing a Central Bank has a direct inflationary impact. Before the Central Bank began, banks kept their reserves in gold; now gold flows into the Central Bank in exchange for deposits with the Bank, which are now reserves for the commercial banks. But the Bank itself keeps only a fractional reserve of gold to its own liabilities! Therefore, the act of establishing a Central Bank greatly multiplies the inflationary potential of the country.

The essence is, an inflationary or deflationary outcome depends largely on central bank directives.

Inflation expands the power of central banks, deflation does not. Guess which route central bankers are likely to chose? (Of course, this assumes that the market can still bear with the effects of central bank policies)