David Glasner points out that one could consider Fed "tightening" starting as early as 2006:
... Beckworth and Ponnuru themselves overlook the fact that tightening by the Fed did not begin in the third quarter – or even the second quarter – of 2008. The tightening may have already begun in as early as the middle of 2006.
That's what I said:
The Fed both reduced the monetary base (M0 and MB) and [effectively] raised interest rates (also dependent on MB and M0) starting after 2005 relative to a log linear path of monetary policy from the early 2000s.
Or here:
The Fed was effectively raising interest rates gradually from well before the onset of the financial crisis by having the base grow more slowly than NGDP.
Surely, slowing private sector demand for credit had role to play in the slowdown in monetary base growth? Home prices soften, credit slows (less collateral and less demand), required reserves and base does not grow fast. The only way Fed could have kept the base growing is by encouraging more credit growth--at a time when we had crazy financing in housing.
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I would completely agree that it is possible that the Fed couldn't help but "tighten" given the economic situation (so isn't 'culpable' for the financial crisis/recession). My post was about the onset of what could be considered "tightening" happening well before 2008.
DeleteHowever, I do believe the Fed was too focused on inflation and could have started lowering interest rates more, sooner.
In the IT model, the effective rate increase actually pushes the economy off the NGDP-M0 path, setting up conditions for a big financial crisis. Lowering interest rates would have expanded the base (in the IT model) ... i.e. stop piling up snow on the mountain. But the effective rising rates had already piled up a bunch of snow, so a crash was inevitable. Not lowering rates faster probably meant a worse recession.
Here is the picture in the IT model.
I agree that the Fed could have lowered rates earlier. But that would have meant keeping credit growing in one form or another. Basically, monetary fixes only increase debt problems. If the financial sector knows that it will be bailed out then taking more leverage always makes sense. Ultimately, debt has to be either monetized (which is a fiscal action), written off or take over by fiscal authority (eg. Fannie/Freddie conservatorship).
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