The Great Recession Critical Term Paper
The response of the Fed towards the Great Recession was ineffective and magnified the initial problems instead of mitigating their effects. The Fed misconceived the cause of the Great Recession to be in the housing market while, in reality, it lay in the misguided policy embraced by the Federal Reserve (Hetzel, 2009). The first approach that the Fed adopted towards resolving the economic collapse experienced in 2008 involved addressing the housing crisis which was just a distraction and not the primary challenge. Although the real estate hurdles could potentially have led to a recession, it would have been a weak one. The Fed prioritized on bailing out financial institutions caught up in many bad mortgages in fear of the potential risks involved. The resolution posed a significant danger since the Fed ignored essential factors such as GDP (Gross Domestic Product) and NGDP (Nominal Gross Domestic Product).
The Fed could have safeguarded the economic stability of the nation by controlling NGDP through its monetary policy. It should have responded to the NGDP fall experienced in 2008 by reducing interest rates rapidly. The approach should, however, have served only as a trial and error technique. Therefore, if it failed to materialize, the Fed should have turned to quantitative easing to increase the money supply. The grave mistake committed by the Fed and which accelerated the recession was the fear of inflation which misguided the institution to keep interest rates too high for an extended period. The approach resulted in the fall of GDP even further.
In the future, it is commendable for the Fed to shift its focus from inflation to NGDP. The institution should understand the dynamics of a recession, for instance, its first influence is the fall of NGDP, not inflation. Therefore, if the focus of a central bank is on inflation, the response might be slow, but it would be quicker if the target was NGDP.
Hetzel, R. L. (2009). Monetary policy in the 2008-2009 recession. FRB Richmond Economic Quarterly, vol.95, no. 2, pp. 201-233.