UNITED STATES MONETARY POLICY IN THE POST-BRETTON WOODS ERA Did it cause the Crash of 2008?
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Yanis Varoufakis: Department of Economics, National and Kapodistrian University of Athens, and Lyndon B. Johnson School of Public Affairs, University of Texas at Austin.
Working papers from Financialisation, Economy, Society & Sustainable Development (FESSUD) Project
The Crash of 2008 is often blamed on the Fed’s overly ‘loose’ monetary policy after 2001 (see Taylor, 2009, 2010). In short, the argument goes, American monetary policy was too ‘loose’ for four years between 2002 and 2006; and too ‘tight’ once the Fed realised that it was presiding over an unsustainable boom. This paper argues that the causes of 2008 and its aftermath (i.e. the stuttering ‘recovery’ once financial markets were successfully stabilised) run much deeper than ‘suboptimal’ monetary policy by the Fed. It argues that, by the end of the 1970s, the Bretton Woods system had been replaced with a ‘brave new’ global surplus recycling mechanism in which Wall Street and the rest of the West’s large private banks featured prominently. These developments engendered a new form of ‘private money’ over which the Federal Reserve had decreasing control. Thus, if the Fed did indeed lose control over the effective money supply it lost it not because of any ‘deviation’ from Taylor-rule-based central banking but, rather, because of a major shift in the global role of finance. To understand why the Fed lost much of its influence over the aggregate money supply we first need to understand how this new form of private money had become an indispensible aspect of the aforementioned recycling mechanism. Wall Street’s generation of private money was, in fact, functional to the recycling of global surpluses upon which the ‘Great Moderation’ was founded. This put the Fed in an impossible dilemma: Should it re-assert its control over the effective money supply at the expense of ending the illusion of the Great Moderation? Or should it stick to Taylor-rule like central banking? This paper argues that the Fed opted for the latter. The paper is structured as follows. Sections 1 and 2 offer a non-technical analysis of the arguments outlined above. Section 3 turns to the post-2008 period and asks; Given that the official sector stabilised financial markets, why has recovery proved so tepid? The answer Section 3 provides is an extension of the analysis in Sections 1&2 regarding the true causes of the Fed’s loss of control over the effective money supply well before the Crash of 2008. Along the same lines, it presents a particular critique of the Fed’s Quantitative Easing policy. Section 4 concludes. In addition to its four main sections, the paper offers three analytical appendices. Appendix 1 presents empirical evidence of the Fed’s loss of control over the effective money supply. Appendix 2 supports these observations with a fully dynamic game theoretical analysis of the Fed’s conundrum during the 1980-2008 period. Lastly, Appendix 3 focuses on the unrealistic assumptions under which Quantitative Easing might spearhead recovery
Keywords: Federal Reserve; Central Bank Games; Financial Crisis; Taylor Rule; Monetary Policy; Quantitative Easing (search for similar items in EconPapers)
JEL-codes: C72 E42 E44 E51 E52 E58 F02 F33 (search for similar items in EconPapers)
Pages: 77 pages
New Economics Papers: this item is included in nep-cba, nep-hpe, nep-mac and nep-mon
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