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If inflation increases rapidly, how do we know that higher interest rates will bring prices under control? And how do we know how much of the monetary 'medicine' to administer? [...]

Policymakers disagree over whether central banks should use interest rates to curb leverage and asset price booms. Higher interest rates make mortgages more expensive and could prevent borrowers from bidding up house prices to create a boom. However, rough calculations show that the size of rate increase needed to do so might also boost unemployment and push down inflation. Thus, using this type of policy tool may cause the central bank to deviate significantly from its goals of full employment and price stability., Wild swings in asset prices over the past 20 years and the associated boom-bust cycles have sparked considerable debate about how monetary policy might play a stabilizing role (see, for [...]

In the six decades following World War II, bank lending measured as a ratio to GDP has quadrupled in advanced economies. To a great extent, this unprecedented expansion of credit was driven by a dramatic growth in mortgage loans. Lending backed by real estate has allowed households to leverage up and has changed the traditional business of banking in fundamental ways. This 'Great Mortgaging' has had a profound influence on the dynamics of business cycles., Leverage is risky. Purchasing assets with borrowed money can amplify small movements in prices into extraordinary gains or crippling losses, even default. From the mid-1980s to the Great Recession, an [...]

An accurate measure of economic slack is key to properly calibrating monetary policy. Two traditional gauges of slack have become harder to interpret since the Great Recession: the gap between output and its potential level, and the deviation of the unemployment rate from its natural rate. As a consequence, conventional policy rules based on these measures of slack generate wide-ranging policy rate recommendations. This variability highlights one of the challenges policymakers currently face., It would be a mistake to characterize the Great Recession as simply a run-of-the-mill economic downturn, only larger in magnitude. In the post-World War II era the United States experienced [...]

The traditional relationship between unemployment and output growth known as Okun's law appeared to break down during the Great Recession. This raised the question of whether this rule of thumb was still meaningful as a forecasting tool. However, recent revisions to GDP data show that its relation with unemployment followed a fairly typical cyclical pattern compared with past deep recessions and slow recoveries. The comparatively common patterns suggest that rumors of the death of Okun's law during the Great Recession were greatly exaggerated., Arthur Okun (1962) described the consistent relationship between changes in output and changes in unemployment that has become a standard tool for monetary policymakers and forecasters. The statistical relationship he [...]

Recovery from a recession triggered by a financial crisis is greatly influenced by the government's fiscal position. A financial crisis puts considerable stress on the government's budget, sometimes triggering attacks on public debt. Historical analysis shows that a private credit boom raises the odds of a financial crisis. Entering such a crisis with a swollen public debt may limit the government's ability to respond and can result in a considerably slower recovery., In financial crises, steep declines in output worsen the ratio of public debt to gross domestic product (GDP) even if the nominal amount of debt remains unchanged. Progressive tax systems [...]

The well-known Phillips curve describes inflation as a persistent process that depends on public expectations of future inflation and economic slack, a measure of how stretched the economy's resources are. The role of each component has changed over time. In particular, maintaining the public's expectations that the Federal Reserve is committed to an inflation target of 2% has grown in importance over the slack component, in part because realigning expectations is costly to undo. Such considerations are important as the Federal Reserve evaluates its future policy options., The U.S. economy is running well above long-term sustainable growth according to many measures. The Congressional Budget Office says output 'is projected to grow slightly faster than its maximum sustainable [...]

The Federal Reserve was created 100 years ago in response to the harsh recession associated with the Panic of 1907. Comparing that recession with the Great Recession of 2007-09 suggests the Fed can mitigate downturns to some extent. A statistical analysis suggests that if a central bank had lowered interest rates during the 1907 panic the same way the Fed did during the 2008 financial crisis, gross domestic product would have contracted two percentage points less than it actually did., This year marks the 100th anniversary of the Federal Reserve System. Two of the Fed's main duties are acting as lender of last resort in times of crisis, and promoting [...]