What were they thinking? The Federal Reserve in the run-up to the 2008 financial crisis

The Federal Reserve (the Fed) is responsible for monitoring, analyzing and ultimately stabilizing US financial markets. It also has unrivalled access to economic data, high-level connections to financial institutions, and a large staff of professionally trained economists. Why then was it apparently unconcerned by the financial developments that are now widely recognized to have caused the 2008 financial crisis? Using a wide range of Fed documents from the pre-crisis period, particularly the transcripts of meetings of the Federal Open Market Committee (FOMC), this paper shows that Fed policymakers and staff were aware of relevant developments in financial markets, but paid infrequent attention to them and disregarded significant systemic threats. Drawing on literatures in economics, political science and sociology, the paper then demonstrates that the Fed’s intellectual paradigm in the years before the crisis focused on ‘post hoc interventionism’ the institution’s ability to limit the fallout should a systemic disturbance arise. Further, the paper argues that institutional routines played a crucial role in maintaining this paradigm and in contributing to the Fed’s inadequate attention to the warning signals in the pre-crisis period.