I should be thrilled that a new paper by economists at the Federal Reserve, Lin, Tsomocos, and Vardoulakis (LTV) shows that tight money increases defaults and contributes to the making of a financial crisis. That’s what Market Monetarists, particularly Scott Sumner, have been saying all along happened in 2008-09.

But even though it is likely as close as we’ll ever get to anyone at the Fed admitting that the conduct of monetary policy contributed to the severity of the financial crisis, it exacerbates my feelings of righteous indignation as it treats default as if it is an individual choice based on the value of collateral. In short, they posit that if a person takes a long term loan out on their home to, say, start a business, if the value of the home declines, they simply choose to lose the property instead of repay the loan. LTV play with flexible prices and General Equilibrium models to come to their conclusion – that it’s part monetary policy but mostly deadbeats by choice. Never mind that demand and subsequently income atrophies. Never mind the possibility that we’re already taking it in the shorts with an oil shock and losing a job due to the passive tightening of policy that creates a deflationary environment doesn’t pay the bills that are now worth more than they were before. Can’t squeeze blood out of turnips, and LTV skirt the issue of how so many people turn into turnips relatively overnight.

I suppose that I can’t blame LTV for not fessing up. I am sure they already took as many steps toward the edge as they possibly can in an institution where there is seemingly no shortage of Clarles Plossers, Elizabeth Georges and James Bullards who can’t seem to get that people don’t just all of a sudden decide to not pay their bills en masse. If it looks like a severe disinflation, with a relatively sudden increase in defaults on a massive scale, it probably is one! And it doesn’t matter to me how many times, or in how many ways those at the Fed try to blame others for their own shortcomings, it will take a lot more than a model that assumes perfect competition, general equilibrium, and perfectly flexible prices to prove a point, even if I agree with half of it, because that just isn’t even close to reality.

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