Monetary Policy 10 Years After the Crisis

"At the outset, it’s worth noting that the Fed itself was largely responsible for the credit crunch that sparked the financial crisis. Easy money might have helped fuel the housing bubble in the early- to mid-2000s, but excessively tight money in the early stages of the crisis almost certainly turned what should’ve been a garden-variety recession into the Great Recession.

Rather than providing sufficient liquidity in a timely manner to prevent the bursting of the housing bubble from spiraling into an economy-wide credit contraction, the Fed chose to siphon liquidity toward specific firms and sectors at the expense of the general economy. Two of the main beneficiaries of this “preferential credit allocation” were the Fed’s primary dealers (two dozen or so of the largest, “too big to fail” banks that serve as the Fed’s counterparties when it conducts open market operations) and firms heavily invested in the housing sector. To quote from our article: "In all of its mid-crisis and post-crisis improvisation, the Fed departed from a focus on overall market liquidity and stability of aggregate demand. It allocated credit to specific firms and sectors at the expense of the general market." (p. 370)"