Was the Fed Too Easy for Too Long?

Introduction

Between January 2001 and June 2003, the Federal Reserve cut the target federal funds rate from six-and-a-half percent to one percent—the lowest level in decades. The Fed then held to that target until June 2004, before raising the funds rate slowly and steadily during the following two years. Some observers have argued that the Fed kept rates too low for too long, and that the abundance of low-cost credit set the stage for the housing boom-bust and current financial turmoil. If correct, this criticism would have important implications for the future conduct of monetary policy.

However, the criticism is not consistent with overall macroeconomic conditions as seen in the past four years or projected by most forecasters for next year. The paths of inflation and unemployment imply that monetary policy should have been a little less expansionary during this period, but the slightly better policy that one can envision with hindsight would not have materially altered recent events. Before going on, I must note that I worked on economic forecasting and analysis at the Federal Reserve Board from 2001 through 2007. This discussion, though, is based entirely on public data and published model results.