Major Federal Reserve Policy Moves since 1985:
The Federal Reserve overshoots and overtightens. But the effect on the economy is diminished because more-responsible fiscal policy leads to a fall in the term and risk premiums:
The Federal Reserve eases monetary policy to fight the recession and jobless recovery caused by its previous overshoot:
The Federal Reserve tightens to--successfully--try to keep inflation from rising; the first bond market "conundrum" as the endogenous duration of mortgage-backed securities produces a much tighter-than-expected gearing between the short-term safe nominal interest rate i and the long-term risky real interest rate r:
The Federal Reserve loosens during the international financial crisis of 1998:
The Federal Reserve tightens to try to prevent "overheating" in the late stages of the dot-com boom:
The Federal Reserve loosens to fight the recession brought on by the collapse of the dot-com boom:
The Federal Reserve keeps policy stimulative and delays its interest-rate tightening cycle given the weakness of the recovery; the bond market first does not and then does credit the Federal Reserve's statements:
The Federal Reserve eases as the magnitude of the subprime-driven financial crisis becomes apparent; but the collapse in financial market trust and the financial crisis come anyway:
With the recovery inadequate, the Federal Reserve decides to extend the period of emergency stimulative extraordinary monetary policy--but the long-term risky real interest rate r sticks at 3%, and does not go any lower:
With the unemployment rate now in the range associated with full employment, the Federal Reserve decides that it is time to "normalize" interest rates:
The Federal Reserve has overdone it on inflation control--successfully kept inflation from getting "too high", and in fact pushed inflation "too low":
Before 2008, macroeconomic stabilization performance on full employment was quite good. 2008-2010 was a disaster. How we evaluate what follows depends on whether we look at unemployment or employment:
Structural Adjustment: "Pounding Nails in Nevada..."
Was a recession in 2009 any sense "needed" to move people out of construction employment as the housing boom collapsed? Was a rise in unemployment a necessary first step in rebalancing the late-2000s economy?
No: Look at the key components of aggregate demand:
As of November 2008, when John Cochrane gave his "we should have a recession... people who spend their lives pounding nails in Nevada need something else to do..." keynote address to the 2008 CRSP Forum, residential investment had already fallen by 3.5%-points of GDP and was within 0.5%-points of what had been its nadir. The recession came after* the move of labor out of construction had been all but completely finished:*
*If you were going to say "we should have a recession" on the grounds that a recession was a necessary part of the structural adjustment required to climb down from overinvetment in housing, the moment to have said that was 2005. And those who said that then were wrong: we did not read a recession in order to move those "pounding nails in Nevada" into other sectors while keeping them employed...