* Floored: How a Misguided Fed Experiment Deepened and Prolonged the Great Recession
By George Selgin
Washington, D.C.: Cato Institute, 2018.
Pp. xviii, 205. $16.95 paperback.
When Federal Reserve officials first announced in 2008 their plan to engage in quantitative easing, many believed that inflation would soon follow. The Fed's rapidly expanding balance sheet, the argument went, would cause the money supply to balloon and the price level to skyrocket. Yet in the years since the plan was instituted, inflation has remained relatively mild. Why did the predictions of these dire warnings never come to pass? In Floored! How a Misguided Fed Experiment Deepened and Prolonged the Great Recession, George Selgin argues that these outcomes failed to materialize because Fed officials adopted a new operating framework in the midst of the financial crisis that fundamentally transformed the U.S. monetary system.
Selgin's book is a comprehensive analysis of the Fed's new operating framework--known as a floor system--that provides an overview of its origins and an examination of its macroeconomic consequences. Selgin argues that the floor system not only is illegal but also has had several deleterious effects on the U.S. economy and raises serious political economy problems that threaten to further politicize the Fed. Selgin's goal is to convince policy makers and the general public that rather than making the floor system permanent, as some have suggested, the Fed should return to a more conventional operating framework.
As Selgin explains in the book's early chapters, a floor system is an operating framework wherein the central bank's primary instrument of monetary policy is the interest rate that it pays on bank reserves. In a floor system, there is no longer a link between the quantity of reserves in the banking system and the overall stance of monetary policy, which means that increases in the size of the central bank's balance sheet need not lead to increases in the money supply and the price level. By contrast, prior to the financial crisis, the Fed's primary policy instrument was the federal funds rate, which it influenced by varying the quantity of reserves in the banking system via open market operations.
In 2006, Congress authorized the Fed to pay interest on reserves in order to offset the implicit tax that minimum-reserve requirements impose on banks and their depositors. According to Selgin, the original intent behind the law was not to...