This paper reviews the unconventional U.S. monetary policy
responses to the financial and real crises of 2007–09, dividing these responses
into three groups: interest rate policy, quantitative policy, and credit policy. To
interpret interest rate policy, it compares the Federal Reserve’s actions with
the literature on optimal policy in a liquidity trap. This comparison suggests
that policy has been in the direction indicated by theory, but it has not gone far
enough. To interpret quantitative policy, the paper reviews the determination
of inflation under different policy regimes. The main danger for inflation from
current actions is that the Federal Reserve may lose its policy independence; a
beneficial side effect of the crisis is that the Friedman rule can be implemented
by paying interest on reserves. To interpret credit policy, the paper presents a
new model of capital market imperfections with different financial institutions
and roles for securitization, leveraging, and mark-to-market accounting. The
model suggests that providing credit to traders in securities markets is a more
effective response than extending credit to the originators of loans.
