The Great Recession = Policy Failure

Book review posted on LinkedIn.   The Great Recession: Market Failure of Policy Failure?




Comment: "It's makes great political theater to pin the recession on GWB and 'deregulation', or to blame BHO's 'socialism' for the lethargic recovery, and there's might be some amount of truth to both of those positions. However, the real issue is that we rely too much on discretionary policy from both parties, which is too often a very long lever of political expediency and the quest for power.

Hetzel's book is an powerful indictment of the politics over rules phenomenon seen too often in DC. The Great Recession is an excellent example of the folly of excessive discretion. The Federal Reserve used to at least try and appear above the fray of politics and made decisions primarily on economic data, experience, and a guide for monetary policy called the "Taylor Rule". Within the ubergeek world of economists, the TR is a well-known approach to determining interest rates, but it's biggest benefits is that it doesn't incorporate politics in its calculations. Said another way, it's not subject to politics or other discretionary factors. Starting in 2002-2003 the Fed decide to move away from the TR and became overly concerned with the politics of the economy. They quietly adopted a new 'rule' for establishing interest rates that has since been referred to as the "Leaning Against the Wind with Credibility" or LAW with Credibility. (We should've walked away from it based on name alone). Historically the Fed's goal has been price stability...primarily fighting inflation but sometimes fighting deflation. The TR works great if the goal is price stability. Unfortunately the Fed decided to change its mission from price stability to controlled inflation - about 2% per year. A new goal meant a new approach, hence the abandonment of the TR and the adoption of LAW+C. Interest rates were held too low for too long which allowed the economy to grow too much too quickly. We had some boom years but they were built on an inappropriately loose money supply and false consumer demand. By late 2005 inflation was rampant in energy, housing, food prices and other areas, and the Fed panicked. From 2006-2008 they raised the Federal Funds rate from 1.25 to over 5.25 in order to cool things off. Guess what - it worked - unfortunately. This stop-and-go-and-stop approach by the Fed led directly to the Great Recession starting in 2008. That's not to say other factors, particularly the lack of confidence consumers had in GWB and DC in general, didn't play a key role in the depth and length of the recession, they did. But the fundamental cause of the recession was a move by the Fed away from the mission of price stability and towards growth. A set of known, proven and apolitical rules wouldn't attain the growth goals quickly enough, so they were replaced with a highly discretionary 'policy' of loose money. The Great Recession was a direct result of this decision and subsequent actions.

It appears the Fed has learned from its mistakes and is moving back towards governing by rules instead of politics. Too bad we won't do the same with government spending."