Stanford professor John B. Taylor, who was Under Secretary of Treasury for International Affairs from 2001 to 2005, has posted a copy of his speech to the annual joint lunch meeting of the American Economic Association and the American Finance Association. Highlights:
My research shows that the low interest rates set by the Fed in 2003-2005 added to the housing boom and led to risk taking and eventually a sharp increase in delinquencies, foreclosures, and toxic assets at financial institutions. The research also shows that a more rules-based federal funds rate would have prevented much of the boom and bust....
Moreover, the highly discretionary on again/off again bailout policies of the Fed did not prevent the panic that began in September 2008; in my view they were a likely cause of the panic, or at least made the panic worse. The unpredictable nature of these interventions could have been avoided, in my view, if the Fed and the Treasury had stated more clearly the reasons behind the Bear Stearns intervention and their intentions for future policy. But no such description was provided. Confusion about policy rose when the TARP was rolled out and panic ensued as the S&P 500 fell by 30 percent. The original stated purpose of the TARP—to buy up toxic assets on banks' balance sheets—was never credibly viewed as operational and it caused uncertainty. It was only when the purpose of TARP was changed and clarified on October 13, 2008 to inject equity into the banks that the panic subsided.
To be sure, the Fed's interventions into the commercial paper market and the money market funds were helpful in rebuilding confidence. So not every discretionary intervention was harmful, but these would not have been necessary had the earlier interventions been avoided.