Federal Reserve 101, Part II: The Global Financial Crisis of 2008 and Its Aftermath
Why the Fed did what it did and why its critics were wrong
Donald Trump has chosen Kevin Warsh, a harsh critic of the Federal Reserve who has called for “breaking some heads,” as the next Fed chair. Last week I wrote about what the Fed is and what it does. Today I’ll talk about the Fed’s policy record, with emphasis on the criticisms offered by Warsh and others.
The history of the Fed is inextricably intertwined with the history of the U.S. economy. You can’t understand the Fed’s policy choices — how, for example, it came to own more than $8 trillion in assets — without understanding the challenges it faced. So today’s post will be structured around historical events and the Fed’s policy responses.
I don’t want to go too far back. There are huge controversies about Federal Reserve policy and its effects during the stagflation of the 1970s, and for that matter during the Great Depression of the 1930s. But these historical controversies aren’t directly relevant to current policy debates.
Nor, I realized while drafting this post, is this the place to discuss recent events — in particular the post-Covid inflationary shock of 2021-2023. To include the debate over that shock would make this post too long. So that’s for next week.
Today I will focus on events and policy disputes after the mid-1980s but before Covid. As I explained last week, by 1985 the Fed’s tight money policy, under the direction of Fed Chair Paul Volcker, had broken the back of persistently high inflation – a hangover from lax monetary policy during the Nixon Administration and oil shocks. Taming inflation cameat a high cost -- an extremely severe recession.
In the aftermath of those epochal events both the U.S. economy and Federal Reserve policy settled into an extended period of relative calm, which economists sometimes call the Great Moderation. However, calm never lasts. In 2008 the United States and the world economy as a whole were wracked by the global financial crisis. The Fed’s response to that crisis was deeply controversial, with harsh criticism coming especially from the political right.
Then, just as the Fed was trying to “normalize” its policies, Covid struck, followed by a severe bout of inflation. The Fed’s response also remains deeply controversial — but that’s for the next primer.
Why does this history matter? Because, to a remarkable extent, attacks on the Federal Reserve today are coming from the same people who were vituperatively critical of the Fed during the global financial crisis and its aftermath. Over time, the Fed’s choices in response to the crisis were overwhelmingly vindicated by the economy’s response to those choices, which refuted the claims of the Fed’s harsh critics. But the turning of the political wheel has now put the people who were proved wrong about monetary policy in charge of Trump administration policy. And, in the person of Kevin Warsh, in charge of the Fed itself. So monetary policy disputes from the global financial crisis era remain all too relevant.
Beyond the paywall I will address the following:
1. Federal Reserve policy before the global financial crisis
2. Federal Reserve policy during and after the global financial crisis
3. The debate over quantitative easing
4. Why this history matters now
