When the Fed Does Too Much

If you think through all of the variables that shape a country’s economy, it’s no wonder that monetary policy is difficult. It should also come as no surprise that the Federal Reserve doesn’t always get it right. In fact, sometimes the Fed’s actions have made the economy worse off.

Prior to the Great Recession, and in response to the recession of 2001, the Fed took steps to stimulate aggregate demand. It kept interest rates low, which meant that credit was cheap – including credit for stuff like mortgages.

Cheap credit has the potential to fuel asset bubbles. For example, in the early to mid 2000s, housing prices were increasing year over year. Both buyers and lenders became overconfident. And, while it’s easy for us to see what happened in hindsight, very few people spotted the trouble ahead.

This is an example of where action was the problem. But what about inaction? Most economists agree that the Fed’s choice to not increase the money supply in the 1930s actually made the Great Depression worse.

If the Fed could have foreseen the housing crisis, what could they have done to prevent it? What are some different viewpoints on the role of the Fed? We’ll cover these in detail in the video (and the quantity theory of money will make a reappearance!).