This book contains a series of lectures given to undergraduates at George Washington University in March 2012. Ben Bernanke, Chairman of the Federal Reserve System, explains actions taken by the Fed during the 2007/08 crisis within the context of its history. The key lesson from the book is that the Fed has learned from its mistakes. The book is a very useful primer on what the Fed is, does, and how it has dealt with the crisis. The question and answer section is captivating because the answers give more insights into Bernanke's current policy views.

Lecture 1 surveys the evolution of central banks as they learned to act as lenders of last resort, follows Bagehot's strictures, and provides price stability by managing the gold standard. Established to deal with the endemic banking panic problem of the national banking system, President Wilson's compromise in 1913 led to a federal central bank with twelve regional (autonomous) reserve banks. In the 1920s the Fed failed to prevent the Great Contraction of 1929 to 1933. According to Bernanke, this failure originated with a bad idea—the liquidationist hypothesis. The liquidationists believed that the Fed should contract credit during recessions. This emphasis on the role of liquidationists stands in contrast with Milton Friedman and Anna Schwartz (A Monetary History of the United States 1867 to 1960. Princeton, NJ: Princeton University Press, 1963a), who emphasize a failure of leadership, and Allan Meltzer (A History of the Federal Reserve, Volume I, 1913–1951. Chicago: University of Chicago Press, 2003), who argues that the Fed was misled by adherence to erroneous indicators of monetary conditions and failed to distinguish between nominal and real interest rates. FDR ended the panic and deflation by instituting deposit insurance and leaving the gold standard. The lesson is for the Fed to avoid the policy errors of the 1930s.

Lecture 2 discusses the aftermath of the Great Contraction. Congress revised the Federal Reserve Act to diminish the independence of the Reserve Banks and concentrate power in the Washington Board of Governors. From the mid-1930s to 1950 the Fed was subservient to the Treasury. During World War II the Fed pegged both short-term and long-term interest rates at low levels to aid Treasury funding. After the relaxation of wartime price controls, the low interest rate peg engendered rising inflation in the late 1940s. Eventually, the Fed regained its operational independence to use its interest rate tools to fight inflation. Under Chairman William McChesney Martin, the Fed maintained a relatively stable macroeconomic environment from the 1950s to mid-1960s. Starting in 1965 expansionary monetary policy led to rising inflation, where Bernanke locates the origins of the Great Inflation. Other factors he cites include OPEC and the Fed's cooperation with the Treasury. Bernanke praises Paul Volcker for breaking the back of inflation with his contractionary policies from 1979 to 1982. The Great Moderation episode from the mid-1980s to 2006 was characterized by low and stable inflation, mild business cycle fluctuations and rapid economic growth. The success of the Great Moderation, according to Bernanke, is attributed to Volcker and Greenspan's strategy of maintaining credibility for low inflation.

The lecture ends with Bernanke's defense of the recent Fed actions against the charges of John Taylor (“Housing and Monetary Policy” in Housing, Housing Finance and Monetary Policy. Federal Reserve Bank of Kansas City, 2007) and others who argue that the boom was fueled by the Fed keeping rates too low. Bernanke's preferred explanation for fueling the boom is a savings glut in Asia and demand for safe U.S. securities that interacted with the collapse of house prices.

Lecture 3 elaborates on the subprime mortgage crisis and the Fed's policies to mitigate it. The crisis, he argues, reflected private sector vulnerabilities: excessive debt, the failure of the banks to monitor risk, short-term funding, the proliferation of derivatives; and public sector vulnerabilities including: gaps in regulation, the failure to detect systemic risk, and flaws in the practices of Fannie Mae and Freddie Mac, that led to the proliferation of subprime mortgages in mortgage backed securities (MBS). The 2008 financial crisis, according to Bernanke, was centered in the non-bank financial system. Losses on subprime mortgages led to losses in MBSs and CDSs (credit default swaps—insurance contracts on the MBSs). The toxic subprime assets were distributed widely in MBSs leading to uncertainty in the financial markets. This led to reductions in short-term funding; runs on the financial markets led to a collapse in funding for investment banks. The first such non-bank financial firm was Bear Stearns in March 2008, which the Fed rescued by subsidizing a merger with JP Morgan Chase. The crisis later spread to the GSEs which were rescued, then to the investment bank Lehman Brothers which was allowed to fail, and to the giant insurance company, AIG, which was bailed out. Bernanke justified the Bear Stearns and AIG bailouts on the grounds that they were too big and they were solvent. Lehman was let go because it was deemed insolvent and because the Fed lacked the legal authority to rescue it. Bernanke viewed this experience as the successful application of Bagehot's rule and lender of last resort policy in marked contrast to what happened in 1930–1933; preventing the collapse of the global financial system.

Lecture 4 describes how tools of conventional monetary policy were used to prevent a repeat of the Great Contraction. The Fed cut its funds rate aggressively in fall 2007 and fall 2008 virtually to zero. Once attaining the zero lower bound, the Fed shifted to quantitative easing (QE)—open market purchases of long-term Treasury securities and MBSs. The theoretical justification was the portfolio adjustment mechanism first posited by Friedman and Schwartz (“Review of Economics and Statistics.” Money and Business Cycles (February 45b) 32–64, 1963b). QE1 began March 2009 and QE2 in March 2010, and led to almost a tripling of the Fed's balance sheet. According to Bernanke, these policies were successful in lowering long-term interest rates. However, the housing sector did not begin to recover until early 2013. Bernanke also discusses his view of the Fed's dual mandate—to maintain low inflation and low unemployment. In 2012 the Fed adopted a 2 percent inflation target and commitment to maintain expansionary monetary policy until unemployment was reduced to the natural rate. He emphasizes his commitment to transparency in monetary policy as evidenced by his introduction of press conferences after FOMC meetings and of forward guidance—announcements on the future path of policy rates. Although optimistic about economic recovery and the role of aggressive monetary policy, he admits that the Fed cannot solve all of the economy's ills, and expresses concern over the slow recovery from the Great Recession.

The final discussion involves the changes regulatory policy incorporated in the 2010 Dodd Frank Bill. The legislation gave the Fed new powers to deal with systemic risk. At the same time, Dodd-Frank reduced the Fed's ability to deal with a future crisis by removing its powers to set up discount window facilities for non-banks (cf. Gary Gorton and Andrew Metrick. “The Federal Reserve and Financial Regulation: The First Hundred Years.” NBER Conference on the Federal Reserve Centennial. Cambridge, MA, July 10, 2013). The conclusion is a reiteration of Bernanke's “back to the future” theme. The Fed was established to conduct monetary policy and preserve financial stability, but failed at both in the 1930s. It learned from its mistakes during the Great Moderation, after lapsing in the Great Inflation, and has now learned from its mistakes in providing financial stability.

These are compelling lectures, but deserve some critique. As Fed chairman, Bernanke at times appears to justify what the Fed did on his watch, often paying little attention to criticisms. In lecture 3, he dismisses the view that expansionary monetary policy fueled the housing boom by citing the countries of Ireland and Spain which had housing booms without expansionary monetary policy. Yet there is a considerable body of evidence that expansionary monetary policy was a significant contributory factor to many housing booms in the past century (Michael Bordo and John Landon Lane, “What Explains Asset Price Booms: History and Empirical Evidence.” Rutgers University, 2013).

The author also skates over the Lehman collapse. There is no discussion of the possibility that the Fed let Lehman go to prevent moral hazard. One wonders whether the crisis in September/October 2008 could have been avoided if Bear Stearns had failed in March. Had it simply been closed and liquidated, it is unlikely that more demand for Fed credit would have come forward than actually occurred. General creditors and derivative counterparties of Bear Stearns were fully protected by its merger with JP Morgan Chase resulted in greater spillover effects than if the Fed appointed a receiver and frozen payments as of the appointment date. Fewer public funds would have been subject to risk. When Drexel Burnham Lambert was shut down in 1990, there were no spillover effects. Furthermore, assume that the moral hazard implications of bailing out Bear Stearns led the remaining investment banks and other market players to follow riskier strategies than otherwise. This surely made the financial system more fragile. When monetary authorities decided to let Lehman fail the shock that ensued and the damage to confidence was much worse (Michael Bordo. “An Historical Perspective on the Financial Crisis of 2007–2008.” NBER Working Paper 14569, December 2008). Additionally, history provides examples when monetary authorities bent the rules and rescued “insolvent” banks whose failure would have led to a panic (relating to Bernanke's claim that the Fed had no legal authority to save Lehman). The chairman's statement reads like ex post hoc ergo propter hoc justification of what turned out to be a disastrous decision.

No mention is made of the critique that the Fed's extension of discount window lending was a form of credit (fiscal) policy— and affected the allocation of resources, which the Fed swore off a half-century ago (Marvin Goodfriend. “The Elusive Promise of Independent Central Banking.” Institute for Monetary and Economic Studies Bank of Japan conference. May 2012). One wonders if the Fed had engaged in general liquidity expansion through open market operations and let the markets determine who will receive the funds, if the outcome would have been any worse (Anna Schwartz. “Origins of the Financial Market Crisis of 2008.” Cato Journal 29, 2008).

Finally, no mention is made of the pause in the Fed's rate cutting in early 2008. According to Robert Hetzel (The Great Recession: Market Failure or Policy Failure. New York: Cambridge University Press, 2012) this policy increased real interest rates and guaranteed a recession would follow even before the collapse of Lehman.

Nevertheless, I highly recommend the book to the educated reader as well as to academic and policy economists. Bernanke has broken new ground by telling his story to the public while still in office.