- A considerable amount of research and literature exists that attempt to explain the policymaking processes of central banks and, in particular, the Federal Reserve Bank (FRB). As with those studies, the purpose of this study is to explain FRB policymaking in order to understand FRB policy shifts during financial crises.
However, this study employs a different theoretical approach. Using the lens of the punctuated-equilibrium (PE) theory I explain policy shifts by the FRB with an emphasis on its preferred policy tool, the federal funds rate. I am unaware of previous research linking the PE theory to FRB policy shifting and as a result my review of relevant literature is focused on the PE theory’s link to closely related macro-level federal institutions.
Since the PE theory’s focus is on moments of punctuation – system shocks – I begin with an overview of the foundational components of the PE theory, asset price bubbles, financial crises, structure of the FRB, and the role of the FRB Chairman. I then drill down on policy shifts that have occurred around moments of punctuation during the Alan Greenspan Chairmanship at the FRB (August 1987 – January 2006).
My methods of analyses are both theoretical and empirical. The foundational components of the PE theory drive the theoretical analysis of FRB behavior and policy shifts. The theory is then statistically tested with empirical data using regression
analysis. The results validate not only the existence of punctuated moments, but also the explanatory power of the PE theory as it relates to FRB policy shifts throughout the Greenspan era.
I conclude with policy recommendations, which include following a policy regime that’s designed to monitor and deal directly with the unwarranted growth of asset price bubbles, undesirable financial market activities, corporate failures that can lead to macro-level financial instability, and other factors that can destroy the balance of the global financial system such as shadow industries that escape regulatory oversight, perverse incentives, and technological innovations.