Skip to main content Accessibility help

We use cookies to distinguish you from other users and to provide you with a better experience on our websites. Close this message to accept cookies or find out how to manage your cookie settings.

Close cookie message
×
Hostname: page-component-cd9895bd7-lnqnp Total loading time: 0 Render date: 2024-12-24T03:20:35.402Z Has data issue: false hasContentIssue false

1 - Introduction

Published online by Cambridge University Press:  13 May 2021

Peter J. Boettke ,
Alexander William Salter  and
Daniel J. Smith
Peter J. Boettke
Affiliation:
George Mason University, Virginia
Alexander William Salter
Affiliation:
Texas Tech University
Daniel J. Smith
Affiliation:
Middle Tennessee State University
Get access

Summary

We provide an overview of the monetary policy failures that resulted in the 2007–2008 financial crisis and ensuing Great Recession, focusing on the United States. Before the crisis, monetary policy was too loose, which fueled the bubble. After the bubble burst, monetary policy became too tight, hindering the recovery. These failures are fundamentally due to the Federal Reserve’s discretionary monetary policy. Furthermore, the popular approach of “constrained discretion” is really just discretion. Hence, it is sensitive to all the usual problems with discretionary monetary policy. Only firm monetary rules, ones that actually bind, can maintain macroeconomic stability and prevent crises.

Keywords

2007–2008 CrisisBen BernankeClassical LiberalismConstrained DiscretionFederal ReserveFinancial CrisisGreat RecessionMonetary Rule
Type
Chapter
Information
Money and the Rule of Law
Generality and Predictability in Monetary Institutions
 , pp. 1 - 21
Publisher: Cambridge University Press
Print publication year: 2021

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Barro, Robert and Gordon, David (1983). Rules, Discretion, and Reputation in a Model of Monetary Policy. Journal of Monetary Economics, 12(1), 101–121.Google Scholar
Berlemann, Michael (2005). Time Inconsistency of Monetary Policy: Empirical Evidence from Polls. Public Choice, 125(1–2), 1–15.Google Scholar
Bernanke, Ben (2002). Remarks by Governor Ben S. Bernanke. Given at the Conference to Honor Milton Friedman at the University of Chicago. Available online (accessed May 14, 2020), www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021108/Google Scholar
Bernanke, Ben (2003). “Constrained Discretion” and Monetary Policy. Remarks before the Monetary Marketers of New York University. Available online (accessed May 14, 2020), www.federalreserve.gov/boarddocs/speeches/2003/20030203/default.htmGoogle Scholar
Bernanke, Ben (2010). Monetary Policy and the Housing Bubble. Speech at the Annual Meeting of the American Economic Association. Atlanta, GA. January 3. Available online (accessed June 20, 2019), www.federalreserve.gov/newsevents/speech/bernanke20100103a.htmGoogle Scholar
Bernanke, Ben (2015). The Taylor Rule: A Benchmark for Monetary Policy? Brookings. Available online (accessed June 20, 2019), www.brookings.edu/blog/ben-bernanke/2015/04/28/the-taylor-rule-a-benchmark-for-monetary-policy/Google Scholar
Bernanke, Ben and Mishkin, Frederic (1997). Inflation Targeting: A New Framework for Monetary Policy? Journal of Economic Perspectives, 11(2), 97–116.CrossRefGoogle Scholar
Bernanke, Ben S. (2013). A Century of US Central Banking: Goals, Frameworks, Accountability. Journal of Economic Perspectives, 27(4), 3–16.Google Scholar
Bernanke, Ben S., Geithner, Timothy F., and Paulson, Henry M. Jr. (2019). Firefighting: The Financial Crisis and Its Lessons. Penguin Books.Google Scholar
Bianchi, Francesco and Melosi, Leonardo (2018). Constrained Discretion and Central Bank Transparency. Review of Economics and Statistics, 100(1), 187–202.Google Scholar
Blinder, Alan (1998). Central Banking in Theory and Practice. The MIT Press.Google Scholar
Blinder, Alan, Goodhard, Charles, Hildebrand, Philipp, Lipton, David, and Wyplosz, Charles (2001). How Do Central Banks Talk? International Center for Monetary and Banking Studies and Centre for Economic Policy Research.Google Scholar
Board of Governors of the Federal Reserve System (2018). Review of Monetary Policy Strategy, Tools, and Communications. Available online (accessed June 19, 2019), www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications.htmGoogle Scholar
Boettke, Peter J. (2012). Living Economics: Yesterday, Today, and Tomorrow. Independent Institute.Google Scholar
Borio, Claudio and Disyatat, Piti (2011). Global Imbalances and the Financial Crisis: Link or No Link? BIS Working Paper No. 346.Google Scholar
Buchanan, James (1958). The Thomas Jefferson Center for Studies in Political Economy. University of Virginia Newsletter, 35(2), 5–8.Google Scholar
Caballero, Ricardo (2010). Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome. Journal of Economic Perspectives, 24(4), 85–102.Google Scholar
Cachanosky, Nicolas and Salter, Alexander William (2017). The View from Vienna: An Analysis of the Renewed Interest in the Mises-Hayek Theory of the Business Cycle. The Review of Austrian Economics, 30(2), 169–192.Google Scholar
Calomiris, Charles and Haber, Stephen (2014). Fragile by Design: The Political Origins of Banking Crises and Scarce Credit. Princeton University Press.Google Scholar
Calvo, Guillermo A. (1978). On the Time Consistency of Optimal Policy in a Monetary Economy. Econometrica: Journal of the Econometric Society, 46(6), 1411–1428.Google Scholar
Calvo, Guillermo A. (2013). Puzzling over the Anatomy of Crises: Liquidity and the Veil of Finance. Bank of Japan Monetary and Economic Studies (November), Working Paper, 39–63.Google Scholar
Clark, Todd E. (2009). Is the Great Moderation Over? An Empirical Analysis. Federal Reserve Bank of Kansas City. Economic Review (Fourth Quarter 2009), 5–42.Google Scholar
Crowe, Christopher and Meade, Ellen (2007). The Evolution of Central Bank Governance around the World. Journal of Economic Perspectives, 21(4), 69–90.Google Scholar
Cutsinger, Bryan (2020). On the Feasibility of Returning to the Gold Standard. Quarterly Review of Economics and Finance, 78, 88–97.Google Scholar
Diamond, Douglas and Rajan, Raghuram (2012). Illiquid Banks, Financial Stability, and Interest Rate Policy. Journal of Political Economy, 120(3), 552–591.Google Scholar
Drazen, Allan and Masson, Paul (1994). Credibility of Policies versus Credibility of Policymakers. The Quarterly Journal of Economics, 109(3), 735–754.Google Scholar
Faust, Jon and Svensson, Lars (2001). Transparency and Credibility: Monetary Policy with Unobservable Goals. International Economic Review, 42)(2), 369–397.Google Scholar
Fischer, Stanley (1995). Central-Bank Independence Revisited. The American Economic Review, 85(2), 201–206.Google Scholar
Florez-Jimenez, Maria Lucia and Parra-Polania, Julian (2016). Forward Guidance with an Escape Clause: When Half a Promise Is Better Than a Full One. Applied Economics, 48(15), 1372–1381.Google Scholar
Friedman, Benjamin (2006). The Greenspan Era: Discretion, Rather Than Rules. American Economic Review, 96(2), 174–177.Google Scholar
Friedman, Milton and Schwartz, Anna (1963). A Monetary History of the United States, 1863–1960. Princeton University Press.Google Scholar
Geraats, Petra (2002). Central Bank Transparency. The Economic Journal, 112(483), F532–F565.Google Scholar
Gjerstad, Steven and Smith, Vernon (2014). Rethinking Housing Bubbles. Cambridge University Press.Google Scholar
Goodfriend, Marvin and Lacker, Jeffrey (1999). Limited Commitment and Central Bank Lending. Economic Quarterly-Federal Reserve Bank of Richmond, 85(4), 1–27.Google Scholar
Hayek, Friedrich August (1933 [2008]). Monetary Theory and the Trade Cycle. Ludwig von Mises Institute.Google Scholar
Hayek, Friedrich August (1935 [2008]). Prices and Production. Ludwig von Mises Institute.Google Scholar
Henderson, David and Hummel, Jeffrey Rogers (2008). Greenspan’s Monetary Policy in Retrospect: Discretion or Rules? Cato Institute Briefing Papers, No. 109. Available online (accessed June 17, 2019), https://object.cato.org/sites/cato.org/files/pubs/pdf/bp109.pdfGoogle Scholar
Herrendorf, Berthold and Lockwood, Ben (1997). Rogoff’s “Conservative” Central Banker Restored. Journal of Money, Credit, and Banking, 29(4), 476–495.Google Scholar
Hetzel, Robert (1997). The Case for a Monetary Rule in a Constitutional Democracy. Federal Reserve Bank of Richmond Economic Quarterly, 83(2), 45–65.Google Scholar
Hetzel, Robert (2012). The Great Recession: Market Failure or Policy Failure? Cambridge University Press.Google Scholar
Hogan, Thomas (2015). Has the Fed Improved U.S. Economic Performance? Journal of Macroeconomics, 43, 257–266.Google Scholar
Hogan, Thomas, Le, Linh, and Salter, Alexander William (2015). Ben Bernanke and Bagehot’s Rules. Journal of Money, Credit and Banking, 47(2–3), 333–348.Google Scholar
Hogan, Thomas, Smith, Daniel, and Aguiar-Hicks, Robin (2018). Central Banking without Romance. The European Journal of Comparative Economics, 15(2), 293–314.Google Scholar
Horwitz, Steven and Luther, William (2011). The Great Recession and Its Aftermath from a Monetary Equilibrium Theory Perspective. In Kates, Steven (Ed.), The Global Financial Crisis: What Have We Learnt? Edward Elgar Publishing, pp. 75–92.Google Scholar
Ireland, Peter (1999). Does the Time-consistency Problem Explain the Behavior of Inflation in the United States? Journal of Monetary Economics, 44(2), 279–291.Google Scholar
Jenson, Henrik, Petrella, Evan, Ravn, Søren Hove, and Santoro, Emiliano (2020). Leverage and Deepening Business-Cycle Skewness. American Economic Journal: Macroeconomics, 12(1), 245–281.Google Scholar
Jordà, Òscar, Schularick, Moritz, and Taylor, Alan M. (2017). Macrofinancial History and the New Business Cycle Facts. In Eichenbaum, Martin and Parker, Jonathan A. (Eds.), NBER Macroeconomics Annual, volume 31, pp. 213–263.Google Scholar
Kohn, Donald (2007). John Taylor Rules. Speech at the Conference on John Taylor’s Contributions to Monetary Theory and Policy. Federal Reserve Bank of Dallas, Dallas, TX. October 12. Available online (accessed June 20, 2019), www.federalreserve.gov/newsevents/speech/kohn20071012a.htm.Google Scholar
Koppl, Roger (2014). From Crisis to Confidence: Macroeconomics after the Crash. The Institute for Economic Affairs.Google Scholar
Kydland, Finn E. and Prescott, Edward (1977). Rules Rather Than Discretion: The Inconsistency of Optimal Plans. Journal of Political Economy, 85(3), 473–491.Google Scholar
Kydland, Finn E. and Wynne, Mark A. (2002). Alternative Monetary Constitutions and the Quest for Price Stability. Federal Reserve Bank of Dallas, Economic & Financial Policy Review, 1(1), 1–19.Google Scholar
Leijonhufvud, Axel (2009). Out of the Corridor: Keynes and the Crisis. Cambridge Journal of Economics, 33(4), 741–757.Google Scholar
Lohmann, Susanne (1992). Optimal Commitment in Monetary Policy: Credibility versus Flexibility. The American Economic Review, 82(1), 273–286.Google Scholar
Lossani, Marco, Natale, Piergiovanna, and Tirelli, Patrizio (1998). Incomplete Information in Monetary Policy Games: Rules Rather Than a Conservative Central Banker. Scottish Journal of Political Economy, 45(1), 33–47.Google Scholar
McCallum, Bennett (1995). Two Fallacies Concerning Central-Bank Independence. American Economic Review, 85(2), 207–211.Google Scholar
Mehra, Yash and Sawhney, Bansi (2010). Inflation Measure, Taylor Rules, and the Greenspan-Bernanke Years. Economic Quarterly, 96(2), 123–151.Google Scholar
Meltzer, Alan (2009). A History of the Federal Reserve, volume II, Book Two, 1970–1986. University of Chicago Press.Google Scholar
Meltzer, Alan (2011). Politics and the Fed. Journal of Monetary Economics, 58(1), 39–48.Google Scholar
Meltzer, Alan (2012). The Federal Reserve at (Almost) 100. Journal of Macroeconomics, 34(3), 626–630.Google Scholar
Meltzer, Alan (2014). Federal Reserve Independence. Journal of Macroeconomic Dynamics and Control, 49, 160–163.Google Scholar
Miller, Marcus, Weller, Paul, and Zhang, Lei (2002). Moral Hazard and the US Stock Market: Analyzing the “Greenspan Put.” The Economic Journal, 112(478), C171–C186.Google Scholar
Mises, Ludwig von (1949). Human Action: A Treatise on Economics. Yale University Press.Google Scholar
Mises, Ludwig von (1953). The Theory of Money and Credit. Yale University Press.Google Scholar
Mueller, Paul (2019). Ten Years Later: Why the Conventional Wisdom about the 2008 Financial Crisis Is Still Wrong. Cambridge Scholars Publishing.Google Scholar
Nikolsko-Rzhevskyy, Alex and Papell, David (2013). Taylor’s Rule versus Taylor Rules. International Finance, 16(1), 71–93.Google Scholar
Niskanen, William (1968). The Peculiar Economics of Bureaucracy. American Economic Review, 58(2), 293–305.Google Scholar
Obstfeld, Maurice (1997). Destabilizing Effects of Exchange-Rate Escape Clauses. Journal of International Economics, 43(1–2), 61–77.Google Scholar
Orphanides, Athanasios and Wieland, Volker (2008). Economic Projections and Rules of Thumb for Monetary Policy. Federal Reserve Bank of St. Louis Review, 90(4), 304–324.Google Scholar
Persson, Torsten (1993). Designing Institutions for Monetary Stability. Carnegie-Rochester Conference Series on Public Policy, 39, 53–84.Google Scholar
Rogoff, Kenneth (1985). The Optimal Degree of Commitment to an Intermediate Monetary Target. Quarterly Journal of Economics, 100(4), 1169–1189.Google Scholar
Romer, Christina and Romer, David (1997). Institutions for Monetary Stability. In Romer, Christina and Romer, David (Eds.), Reducing Inflation: Motivation and Strategy. Chicago University Press, pp. 307–334.Google Scholar
Salter, Alexander William (2016). Robust Political Economy and the Lender of Last Resort. Journal of Financial Services Research, 50(1), 1–27.Google Scholar
Sargent, Thomas (1999). Central Banking in Theory and Practice: Lionel Robbins Lectures. Journal of Political Economy, 107(2), 419–425.Google Scholar
Schwartz, Anna (2009). Origins of the Financial Market Crisis of 2008. Cato Journal, 29(1), 19–23.Google Scholar
Selgin, George (2016). Real and Pseudo Monetary Rules. Cato Journal, 36(2), 279–296.Google Scholar
Selgin, George (2019). The Fed’s New Operating Framework: How We Got Here and Why We Shouldn’t Stay. Cato Journal, 39(2), 317–326.Google Scholar
Selgin, George, Lastrapes, William, and White, Lawrence (2012). Has the Fed Been a Failure? Journal of Macroeconomics, 34(3), 569–596.Google Scholar
Sevensson, Lars (2003). What Is Wrong with Taylor Rules? Using Judgement in Monetary Policy through Targeting Rules. Journal of Economic Literature, 41(2), 426–477.Google Scholar
Summers, Peter (2005). What Caused the Great Moderation? Some Cross-Country Evidence. Federal Reserve Bank of Kansas City Economic Review, (Third Quarter 2005), 5–32.Google Scholar
Taylor, John (2007). Housing and Monetary Policy. Proceedings – Economic Policy Symposium – Jackson Hole, Federal Reserve Bank of Kansas City, pp. 463–476.Google Scholar
Taylor, John (2009). Getting Off Track. Hoover Institute Press.Google Scholar
Taylor, John (2010a). The Fed and the Crisis: A Reply to Ben Bernanke. The Wall Street Journal. Sunday, January 10.Google Scholar
Taylor, John (2010b). Macroeconomic Lessons from the Great Deviation. NBER Macroeconomics Annual, 25, 387–395.Google Scholar
Taylor, John (2012). Monetary Policy Rules Work and Discretion Doesn’t: A Tale of Two Eras. Journal of Money, Credit and Banking, 44(6), 1017–1032.Google Scholar
Taylor, John (2013). International Monetary Coordination and the Great Deviation. Journal of Policy Modeling, 35(3), 463–472.CrossRefGoogle Scholar
Taylor, John (2014). The Role of Policy in the Great Recession and the Weak Recovery. American Economic Review, 104(5), 61–66.Google Scholar
Tillmann, Peter (2008). The Conservative Central Banker Revisited: Too Conservative Is More Costly Than too Liberal. European Journal of Political Economy, 24(4), 737–741.Google Scholar
Tullock, Gordon. (2005). Bureaucracy. Liberty Fund.Google Scholar
Waller, Christopher and Walsh, Carl (1996). Central-Bank Independence, Economic Behavior, and Optimal Term Lengths. The American Economic Review, 86(5), 1139–1153.Google Scholar
Walsh, Carl (1995). Optimal Contracts for Central Bankers. The American Economic Review, 85(1), 150–167.Google Scholar
White, Lawrence (2012). Monetary Policy and the Financial Crisis. In Beckworth, Davide (Ed.), Boom and Bust Banking: The Causes and Cures of the Great Recession. Independent Institute, pp. 13–26.Google Scholar
White, Lawrence (2015). The Merits and Feasibility of Returning to a Commodity Standard. Journal of Financial Stability, 17, 59–64.Google Scholar

Save book to Kindle

To save this book to your Kindle, first ensure [email protected] is added to your Approved Personal Document E-mail List under your Personal Document Settings on the Manage Your Content and Devices page of your Amazon account. Then enter the ‘name’ part of your Kindle email address below. Find out more about saving to your Kindle.

Note you can select to save to either the @free.kindle.com or @kindle.com variations. ‘@free.kindle.com’ emails are free but can only be saved to your device when it is connected to wi-fi. ‘@kindle.com’ emails can be delivered even when you are not connected to wi-fi, but note that service fees apply.

Find out more about the Kindle Personal Document Service.

Available formats
×

Save book to Dropbox

To save content items to your account, please confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your account. Find out more about saving content to Dropbox.

Available formats
×

Save book to Google Drive

To save content items to your account, please confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your account. Find out more about saving content to Google Drive.

Available formats
×