A Fed official criticising the Fed policies post crisis. This is nothing new for Dan Thornton as he has been doing it for a while.
He divides the crisis in two phases. From Aug-07 to Lehman and Post-Lehman. As per him, Fed should have expanded its balance sheet in the first phase itself as signs of crisis were evident. This would have allowed Fed to be far more pre-emptive
I have argued that the Fed didn’t massively increase the monetary base in early 2008 when it should have but did following Lehman Brothers’ bankruptcy announcement because it had no choice, and also took steps to maintain the monetary base at the post-Lehman level rather than allowing the monetary base decline passively as it should have as financial market stabilized and the recession ended. Faced with unacceptably high unemployment and anemic economic growth, the FOMC tried to stimulate aggregate demand by attempting to reduce longer-term rates using forward guidance, QE, and Operation Twist.
The FOMC’s behavior was motivated by policymakers nearly religious faith in the EH, the fact that the Fed only make loans and investments or controls the federal funds rate either through open mouth operations or by engaging in large-scale open market operations, and the increased emphasis on “financial market frictions” to account for what some see as the apparent historical effectiveness of monetary policy. The last of these helps explain the FOMC’s failure to significantly increase the monetary base in early 2008. The first two account for the zero interest rate policy, QE, and Operation Twist.
The Fed’s response to the financial crisis would have been much better had policymakers taken the massive empirical rejections of the EH seriously, considered the fact that long-term Treasury yields were unresponsive to the 425 basis point increase in the federal funds rate target from June 2004 through June 2006, and believed, as I do, that real long-term rates are largely driven by economic fundamentals, such as the rate of economic growth and are therefore and are effectively independent of countercyclical monetary policy. Moreover, policymakers should take the Fisher equation seriously. If they did, they would realize that a zero nominal interest rate policy is inconsistent with 2 percent inflation and positive economic growth, i.e., a positive real long-run interest rate. While a zero nominal policy rate might be defensible for a relatively short period of time, it is totally indefensibly as a long-run policy
He says Fed has simply chosen to do something:
Finally, I believe that the FOMC’s extreme actions likely reflect Friedman’s (1970) suggestion of a central bank’s version of the natural human tendency to say, ‘For God’s sake, let’s do something,’ when faced by unpleasant developments. The action is its own reward, even if it has consequences that make the developments still more unpleasant.” Unfortunately, extreme actions can have negative consequences for growth and longer-run economic and financial market stability. The long-run economic consequences of such a policy are difficult to predict. However, such policies can have long-run consequences for the Federal Reserve monetary policy; namely, the loss of credibility and influence as the increasingly extreme policy actions generate smaller and perhaps worse outcomes (Wall Street Journal, 2012; Bank for International Settlements, 2012).
Strong critique of Fed policies..