Bernanke on the causes of the financial crisis, questioning how we measure potential economic output, and more new research in economics  

Editions of the Brookings Papers on Economic Activity are pictured

For nearly 50 years, the Brookings Papers on Economic Activity (BPEA)—the academic journal published twice a year by the Economic Studies program at Brookings—has been the leading journal in economics for timely, cutting-edge research about real-world policy issues. Browse the journal’s archives, and you’ll find dozens of papers by former and future policymakers on the most critical economic questions of the last several decades.

The newly-published Fall 2018 edition is no exception. A highlight of the edition is a paper by former Federal Reserve Chair Ben Bernanke that looks back on the financial crisis and resulting Great Recession. Of the paper, Dr. Bernanke says: “I’m trying to understand the mechanisms by which the crisis affected the economy. This was something where I felt as a policymaker, while we did have obviously some information … we didn’t have enough quantitative, rigorous analysis to help us understand how the developments in the financial markets really affected the economy. As a policymaker, I saw that gap. Now that I’m back in a more research-oriented mode, it’s a chance to try to think about this at more leisure, and I hope to contribute to policymaking in the future.”

Keep reading to learn more about Bernanke’s paper and other new research in the Fall 2018 edition, or browse all the papers here. Interested in learning more about BPEA—or being the first to hear when new research is published? Sign up here for email updates.

 Bernanke says housing bust alone can’t explain the Great Recession

In his new BPEA paper, former Federal Reserve Chair Ben Bernanke examines why many forecasters failed to anticipate the severity of the Great Recession and what really drove the economy into such a tailspin.

Bernanke’s research, which is rooted in quantitative analysis of how the 2007-2009 financial crisis affected the economy, argues that the housing bust, while significantly damaging, can’t on its own explain why the Great Recession was so bad. To understand fully the depth and timing of the economic downturn, we should look instead to the subsequent financial panic—including the run on short-term wholesale funding for financial institutions and the subsequent fire sales of credit-related assets—that sharply constrained the supply of credit.

If Bernanke’s findings are correct, then policymakers were right to implement some of the most controversial policies of the financial crisis, including efforts to rescue the big banks and re-start credit markets. By bringing the panic under control relatively quickly, those policies prevented a still deeper and more protracted recession.

To learn more, read Dr. Bernanke’s own summary of the research on his Brookings blog. Or watch the interview below:

 U.S. GDP is much lower than it could be, and policymakers could still help

Every year, the Federal Reserve and other government agencies, as well as various international organizations, produce regular projections of potential output—that is, a “normal” or long-run level of economic activity. Since the Great Recession, these projections have become less and less optimistic, with many now interpreting the data to suggest the U.S. is seeing a permanent decline in economic output.

But what if these projections—and resulting assumptions about the future path of the economy—are subject to mismeasurement? A new paper from Olivier Coibion of the University of Texas at Austin and Yuriy Gorodnichenko and Mauricio Ulate of the University of California at Berkeley suggests they are very likely to be.

Of their research, the authors say: “Our research shouldn’t be interpreted as singling out any individual agency—the CBO, the Fed, and their forecasting counterparts provide valuable economic analysis using state-of-the-art methods despite facing tight budget constraints. Our hope is that these findings illustrate some of the limitations of the methods that are in widespread use and help guide the development of improved real-time estimates of potential GDP.”

The problem with current measurement methods, the authors argue, is that many projections are overly responsive to short-term changes in demand. For agencies like the IMF that are concerned with long-run fiscal trends, a better measure of output or GDP would strip out cyclical variations and focus on long-run changes. When they implement alternative approaches that focus more on long-run changes, the authors find that U.S. potential output hasn’t declined nearly as much as official estimates suggest, and current U.S. GDP remains significantly below what it could be in the long-run.

The study’s results imply that both monetary and fiscal policies in the U.S. could afford to take a more expansionary stance than is currently perceived—that is, policymakers should encourage economic growth by lowering interest rates, cutting taxes, or increasing government spending.

How does the Fed know when it’s time for a change? 

In news coverage of the Federal Reserve, readers will often come across a reference to the Fed’s “dual mandate”—a mission statement authored by Congress that directs the Fed to promote effectively the goals of maximum employment and stable prices. One way the Fed pursues this mandate is through the application of monetary policy. Unsurprisingly, the Fed’s framework for how it applies monetary policy has evolved considerably and frequently over its 100-year charter.

In this edition of BPEA, Boston Federal Reserve Bank economists Jeff Fuhrer, Giovanni Olivei, Geoffrey Tootell, and Boston Fed President Eric Rosengren ask when and how the Fed should re-evaluate its monetary policy framework. “The question,” the authors write, “is not whether the framework can or should change, but what are the appropriate triggers for such changes and what process might best aid the central bank in considering how to change it.” Furthermore, they propose that the Fed “should consider a regular assessment of its [monetary policy] framework at a fixed interval, and that this assessment provide a transparent evaluation of the current framework and how that framework could be improved or possibly changed.”

The paper is full of historical information on the evolution of the Fed’s monetary policy framework—from the reliance on the gold standard to the 2012 framework that explicitly outlines the importance of pursuing both parts of the Fed’s dual mandate—and reasons to re-evaluate its approach. If you’re studying economics in school or just want to know more about how the Fed’s approach to monetary policymaking has evolved, the full paper is worth a read.

To learn more about other papers published in the Fall 2018 edition of BPEA, browse the full edition here.