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ABSTRACT
The Federal Reserve (the Fed) is responsible for monitoring, analyzing and ultimately stabilizing US financial markets. It also has unrivalled access to economic data, high-level connections to financial institutions, and a large staff of professionally trained economists. Why then was it apparently unconcerned by the financial developments that are now widely recognized to have caused the 2008 financial crisis? Using a wide range of Fed documents from the pre-crisis period, particularly the transcripts of meetings of the Federal Open Market Committee (FOMC), this paper shows that Fed policymakers and staff were aware of relevant developments in financial markets, but paid infrequent attention to them and disregarded significant systemic threats. Drawing on literatures in economics, political science and sociology, the paper then demonstrates that the Fed's intellectual paradigm in the years before the crisis focused on ‘post hoc interventionism’ – the institution's ability to limit the fallout should a systemic disturbance arise. Further, the paper argues that institutional routines played a crucial role in maintaining this paradigm and in contributing to the Fed's inadequate attention to the warning signals in the pre-crisis period.
ACKNOWLEDGEMENTS
The authors thank Yuan Wang and Caleb Jones for exceptional research assistance, and John Caskey, Ted Crone, Philip Jefferson, Mark Kuperberg, and Ellen Magenheim for comments and the Swarthmore College Frank Aydelotte Foundation for the Advancement of the Liberal Arts for funding.
Notes
1. As Schonhardt-Bailey Citation(2013, 15) notes, the ‘Fed's original mandate was very much viewed as preventing financial crises and panics…’.
2. It also had the authority to prevent ‘unfair’, ‘abusive’, and ‘deceptive’ practices in high-cost loans under the 1994 Home Ownership Equity Protection Act (Greenspan, Citation2010).
3. As previously noted, although Barth et al. Citation(2012) is an exception, the authors do not focus on the Fed or its transcripts in detail. Schonhardt-Bailey Citation(2013) examines FOMC transcripts roughly from 1979–1999. Rosenhek Citation(2012) investigates the Fed's changing conceptualizations of ‘the crisis’ once the panic in financial markets erupted in late 2007, but does not rely on FOMC transcripts. Holmes Citation(2010) focuses on the Fed's communication of its monetary decisions to the public. Most of the recent work produced on the Fed has examined the implications of the Fed's interventions during the crisis, including quantitative easing and financial sector bailouts (e.g., Blinder, Citation2013; Chinn and Frieden, Citation2012).
4. Although housing bubbles inflated by lending booms and securitization also occurred in several European countries, given our interest in the Fed this section analyzes US housing and financial markets.
5. See, e.g., Coval et al. Citation(2009) and MacKenzie Citation(2011).
6. See, e.g., Engelen et al., Citation2011.
7. The Fed defines the FOMC's role as follows: ‘The Committee reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.’ (http://www.federalreserve.gov/monetarypolicy/fomc.htm).
8. We considered a wide range of terms and phrases and report only the most important here. Atlas allows for similar terms to be grouped in a single search, e.g., CDS and credit default swaps.
9. A prominent exception of a DSGE model with financial frictions is Bernanke et al. Citation(1999).
10. For a critical assessment of the ‘mop-up’ strategy, see Roubini Citation(2006).
11. While Meade Citation(2006) suggests that the go-around impedes the voicing of dissent, we suggest that even if dissent is voiced (as we have shown to be the case), the go-around impedes the impact of dissent on discussions and institutional outcomes.
12. Lombardi and Woods Citation(2008) emphasize the downsides of the consensus-generating nature of IMF staff discussions, a point stressed in the IMF's self-evaluation of its pre-crisis weaknesses (Independent Office of the IMF, Citation2011).
13. Research director David Stockton admitted at the September 2007 FOMC meeting that ‘much of what has occurred [in the financial markets] doesn't even directly feed into our models’ (Federal Reserve, Citation2007: 20).
14. The Fed merged the Greenbook and Bluebook into the Tealbook in 2010 in an attempt to streamline the production and processing of these documents. The effects of this change remain unclear given the five-year delay in the release of these documents.
15. But this did not make it a DSGE model, and overall it was still neo-Keynesian rather than New Classical (Mankiw, Citation2006; Meyer, Citation2004; Pescatori and Zaman, Citation2011).
16. These numbers were almost identical across the different Beigebooks. Discussions about ‘real estate’ primarily consisted of comments about housing prices from construction firms, developers, contractors, and real estate agents. ‘Finance’ consisted of conversations with bankers and information about mortgage volumes, interest rates, delinquency rates, and perceptions of credit standards. ‘Main Street’ comments were centered on manufacturing and retail, but also included infrequent topics like agriculture and tourism.
17. Similarly, the IMF's self-evaluation found that the IMF staff's compartmentalization in isolated ‘silos’ contributed to the institution's failure to appreciate the dangers before the crisis (Independent Evaluation Office of the IMF, Citation2011).
Additional information
Notes on contributors
Stephen Golub
Stephen Golub is Franklin and Betty Barr Professor of Economics at Swarthmore College, Pennsylvania. He has a PhD in Economics from Yale University. Prior to coming to Swarthmore in 1981 he worked at the US Treasury Department and the Federal Reserve Board of Governors. He has also held visiting positions at Yale University, Columbia University, the Wharton School of the University of Pennsylvania and the Haas School of Business at the University of California at Berkeley. He has published numerous articles and co-authored Money Credit and Capital (1998, McGraw Hill) with Nobel Prize-winning economist James Tobin. He has also served as a consultant or visiting scholar at the United Nations, the World Bank, the International Monetary Fund, the Organization for Economic Cooperation and Development, and the Federal Reserve Banks of San Francisco and Philadelphia.
Ayse Kaya
Ayse Kaya is Assistant Professor of Political Science at Swarthmore College, Pennsylvania. She obtained a PhD in Political Science at the London School of Economics. Her research focuses on global economic governance, particularly international economic organizations. She has published papers on that subject as well as on the 2008 crisis and global economic inequality. Her current book manuscript focuses on explaining political asymmetries in global economic institutions. She has been a post-doctoral research scholar and visiting research scholar at Columbia University's inter-disciplinary Committee on Global Thought.
Michael Reay
Michael Reay is Assistant Professor of Sociology at Swarthmore College, Pennsylvania. He holds a PhD in sociology from the University of Chicago, where he also taught in the MA Program in the Social Sciences. He has been teaching sociology at liberal arts colleges since 2002. His research and scholarship focuses on the sociology of knowledge, and he has published papers on the identity and authority of American economists, the nature of orthodox economic theory and its influence on policy, and the uneven distribution of social experience across space and time. He is currently working on a book manuscript titled ‘Economic Figures: Economists as Scientists, Philosophers, Priests and Bureaucrats’.