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The Fed and the Great Recession

How Better Monetary Policy Can Avert the Next Crisis

U.S. Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke leave a ceremony to debut the new design for the $100 note at the Department of the Treasury in Washington, April 2010.   Jim Young / Reuters

Today, there is essentially one accepted narrative of the economic crisis that began in late 2007. Overly optimistic homebuyers and reckless lenders in the United States created a housing price bubble. Regulators were asleep at the switch. When the bubble inevitably popped, the government had to bail out the banks, and the United States suffered its deepest and longest slump since the 1930s. For anyone who has seen or read The Big Short, this story will be familiar.

Yet it is also wrong. The real cause of the Great Recession lay not in the housing market but in the misguided monetary policy of the Federal Reserve. As the economy began to collapse in 2008, the Fed focused on solving the housing crisis. Yet the housing crisis was a distraction. On its own, it might have caused a weak recession, but little more. As the Fed bailed out the banks at risk from

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