The Responsibility Of The Federal Reserve During The Formation Of Sub-prime Crisis

Given the suddenness, scale and seriousness of the subprime crisis as well as the velocity of its development, root causes of this crisis have been studied intensively in the academic world. Notably, the Federal Reserve was viewed as one of the most important factor. Based on relevant research and literature, this article studied Fed's role in the crisis from a different perspective by examining Fed's financial stability function in connection with its monetary policy and macro economic environment. It pointed out that Fed's counter-cyclical monetary policy during the previous down turn raised market participants'risk appetites. Further more, its incompetency in macro prudential regulation not only led to the absence of external risk constrains but also exerted extra burden to the monetary policy. The combined force of the aforementioned factors together with the breakthrough in financial liberalization and financial innovation finally brought the accumulation of risk to an uncontrollable level and hence, a full blown crisis became inevitable. In order to avoid the vicious cycle of Crisis-Intervention-New Crisis, both the macro regulatory structure and the monetary authority in the U.S. have to modernize its policy framework. Establishing an objectives-based regulatory structure seems to be the optimal choice. As a critical part of the reform, granting more regulatory power and policy tools to the Fed will enhance its ability to prevent financial crisis and to provide support to the growth of real economy.