Operationally, central banking had become heavily built around interest rates. In New Keynesian terms, policy works by setting the nominal interest rate relative to the estimated real or natural rate, thereby pushing policy in an inflationary or deflationary direction. But that only works if your estimate of the real rate is roughly correct. In a crisis, when the natural rate is collapsing and financial conditions are tightening rapidly, that framework can become dangerously misleading.

The backward-looking element matters here. In 2008, the Fed put too much weight on lagging inflation indicators, core inflation, and commodity-driven inflation fears when thinking about forward policy. Because of those inflation concerns, it did not cut rates between April 2008 and October 2008, even though the real economy and forward-looking indicators were already signaling serious trouble. Economists like Svensson had already argued for relying more on forecasts and expected inflation rather than backward-looking indicators. Bear Stearns had already happened in March. Yet even around the Lehman collapse, Fed discussion still reflected concern that inflation had been too high and that cutting too aggressively could damage credibility.

So the actual stance of policy was much too tight, and it became tighter in real terms as the economy deteriorated. As expected inflation and nominal spending weakened, a given nominal policy rate translated into a more contractionary real policy stance. That process was self-reinforcing: tight money weakened the economy, the weakening economy worsened expectations, and worsening expectations made the effective stance tighter still.

By late 2008 the Fed had moved close to zero and was beginning to think more seriously about quantitative easing, but it was still not comfortable treating aggressive QE as the main policy instrument. That is where I am very critical of Bernanke. Rather than using monetary policy as aggressively as necessary, he increasingly talked about the limits of monetary policy and the need for fiscal policy to take over. I think that was a major failure of central-bank responsibility. Allowing inflation to turn negative in 2009 while unemployment exploded was not acceptable.

The NGDP numbers make the failure especially obvious. In 2007, NGDP growth was around 5 percent. In 2008 it slowed to around 2 percent, already showing that policy had become too tight. Then in 2009 it fell to roughly negative 2 percent, which is disastrous. Once nominal spending collapses like that, you are no longer dealing only with a housing or banking crisis. You are creating a general recession that hits large parts of the economy that had little direct exposure to housing or finance. That is why technology firms and other businesses far outside housing were also hit so hard: NGDP had fallen massively below trend.

So for me this is fundamentally a case of operational failure. During the Great Moderation, the Fed had become used to relying on gradual, interest-rate-based responses to incoming data. That framework broke down when conditions changed rapidly. Instead of immediately shifting to aggressive balance-sheet expansion and expectation management, the Fed placed too much responsibility on fiscal policy. At that point, older Keynesian themes — the paradox of thrift, the idea that monetary policy becomes ineffective at the zero lower bound, and the need for government demand support — reentered the conversation.

By mid-2008, the Fed should have been much closer to zero and preparing an aggressive, open-ended QE-style program aimed at restoring normal inflation and nominal spending in 2009. A much faster and more aggressive monetary response would likely have reduced the need for large fiscal stimulus and limited the scale of financial rescues. Had they acted that way, this episode might be remembered primarily as the housing and banking crisis, rather than as the Great Recession.

QE1 was enough to stop the collapse from getting even worse, and QE2 and QE3 helped make the United States one of the better post-crisis performers. Even so, the response was still not aggressive enough, especially in 2009. The euro area did much worse and is still paying for it.

What the Fed did not do, even though some monetary economists had argued for it before 2008, was level targeting. The idea is simple: if you fall short of your inflation or nominal-income target for one or two years, you should then aim to return to the pre-crisis trend path rather than simply grow forward from a permanently lower base. That did not happen. Before the crisis, the U.S. had relatively stable NGDP growth of around 5 percent, roughly consistent with 2 to 3 percent real growth plus inflation. Then NGDP fell below trend in 2008 and 2009, and later returned to roughly 4 to 5 percent growth, helped by QE. But ideally, in 2010 and 2011, policy should have aimed for temporarily faster NGDP growth — something like 8 percent — in order to close at least part of the gap back to the old trend.

> he says the Fed may have suffered less from lack of leadership than from the lack of an adequate intellectual framework for understanding what was happening

“It wasn’t leadership, it was the intellectual framework” is a very convenient story for the man who was leading the institution. The basic logic of crisis stabilization — stop nominal collapse, stop deflation, ease aggressively, and use the balance sheet if rates are not enough — was not some unknown mystery in 2008. The failure was operational and intellectual inertia at the top, which is still a leadership failure.

One could argue that we shouldn't have a system where there are a small group of people in control like this, it should be a more automated or at least self correcting system, but train has left the station long ago.