State of the Art

Jane D'Arista

International Journal of Political Economy, 2013, vol. 42, issue 3, 5-23

Abstract: Belief in the efficient markets hypothesis and the adoption of capital requirements for banks as the macro-prudential tool most compatible with market forces replaced the Federal Reserve's earlier commitment to using the link between open market operations and changes in reserve requirements to curb credit. Since severing that lever of influence over the credit supply, the central bank has relied on open market operations to achieve only one objective: to influence the demand for credit by changing the short-term policy rate. The unbalanced monetary toolkit contributed to a pro-cyclical bias in policy outcomes that mirrored and exacerbated the evolving pro-cyclical bias of the financial system. Failure to evaluate and strengthen its monetary tools has undermined the Fed's ability to restore sustained economic growth and prevent another financial crisis.

Date: 2013
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DOI: 10.2753/IJP0891-1916420301

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