Friday, July 17, 2009

Bursting Bubbles

What seems clear is that the nature of monetary policy leading up to recessions has changed dramatically. Pre-Great Moderation, recessions were preceded by tightening policy, presumably to control inflation; the combination of policy tightening and a high underlying inflation rate meant high rates going in, giving lots of room for policy loosening. Increasingly, however, recessions have been the result of bursting bubbles, with monetary policy getting looser even before the recession begins. -- Paul Krugman