The following short essay was written for the Wall Street Journal as part of a symposium in which five economists were asked this same question.
Many will remember Ben Bernanke for classic central bank stabilizing actions taken by the Fed during the fall 2008 panic, including emergency loans to banks and swap lines to foreign central banks. But historians might also consider actions the Fed took before and after that panic.
From 2003 to 2005, shortly after Ben Bernanke joined the Board stressing deflationary concerns, the Fed embarked on a very low interest rate policy. The policy was rationalized in part by these deflationary concerns, but it was a deviation from a policy that had worked well for two decades, and it exacerbated the housing boom and led to excessive risk taking.
The inevitable bust and defaults started as early as 2006. But the Fed misdiagnosed the resulting hits to bank balance sheets as a pure liquidity problem, and its initial treatment — pouring funds into the interbank market via the 2007 Term Auction Facility — did little good. The Fed then followed up with an on-again off-again bailout policy which created more instability. When the Fed bailed out Bear Stearns’ creditors in March 2008, investors assumed Lehman’s creditors would be bailed out too. When they weren’t, it was a big surprise. With policy uncertainty reaching new heights, panic ensued.
After the panic, the Fed began to draw down the emergency loans, but it then embarked on an entirely unprecedented policy — massive purchases of mortgage-backed and Treasury securities, a tool known as quantitative easing, or QE. The economy has grown slowly with QE compared with past recoveries without QE and far short of the Fed’s predictions. Many argue that QE has not reduced unemployment, but has diminished the Fed’s independence and credibility, offsetting the effects of adopting a numerical inflation target. Now, only a year after the latest round of QE began, the Fed is struggling with how to unwind it, just as many had warned.