Notes from: Scott Sumner
Global Financial Crisis Misconceptions
Macro Musings podcast - Oct 2021

Most people have a vision of business cycles where policymakers such as the Fed and fiscal policy are like firemen that come in and put out fire. In this vision, the private economy is inherently unstable and it creates problems, and we have to fix those problems with Federal policies of various sorts. The monetarist perspective that I come from sees policy makers as more like arsonists. This is a little bit cruel, of course, and I don't mean this disrespectfully because they're doing the best they can, but policymakers unintentionally create fluctuations in nominal GDP growth.
     When there are these fluctuations, if it's very high, you get an inflation problem, and if there's a sharp slowdown in nominal GDP growth, you get a severe recession and often a financial crisis. These are predictable effects of a slowdown in nominal GDP growth for two reasons. One is nominal wages are sticky and the other is people contract nominal debts. For that reason, when the flow of nominal income in the economy drop sharply, there's less money to pay workers and less money to service debts. So, you get high unemployment and you get financial stress. And this occurs almost every time. There's a sharp slowdown in nominal GDP. But because it's hard to see the connection between monetary policy and nominal GDP, people reverse the causation and they see what's going on as instability in the private economy causing a recession, and then policy makers coming in to fix the problem. The indicators people use for monetary policy like money growth and interest rates are not really reliable indicators. Therefore, they don't really see how Fed policy could have actually caused the Great Recession by allowing nominal GDP growth to slow sharply.
     But that's in fact, my view of what happened, and I think over time, that has become strengthened by lots of other things that I've learned that I didn't even know when I started blogging. The work of Kevin Erdmann on housing. I learned that the whole idea of a housing bubble was probably a misconception.
     The housing prices were not unreasonable in 2006. The level of housing construction was not in 2006. I think we know that now from some of this recent research. The slowdown in housing construction between beginning of '06 and '08 was not associated with a sharp rise in unemployment. The recession was really caused by a broader drop in nominal GDP growth that affected all industries, not just housing construction. The banking crisis didn't really get severe until the Fall of 2008. That severe banking crisis took place about nine months after the recession started.
     Rather than causing the recession, it was itself a response to slowing nominal GDP growth. Another misconception is that the Fed was doing all it could in 2008. Not only was it not doing unconventional stimulus in 2008, it wasn't even doing all the conventional stimulus. It refused to cut interest rates after Lehman failed in September of 2008, holding them at 2%. A lot of people, I think, sort of misremember the early stages of the Great Recession and have this sense that there was this wildly unstable speculative of economy that collapsed, and the Fed had to come in and clean up the mess. That's just not what happened when you look closely at the data.