For many, the Great Recession and the boom that preceded it are evidence of the failure of the supposed deregulation of financial markets in the last decade and therefore constitute an indictment of capitalism more broadly. However, a closer look at both monetary policy and the effects of other government interventions on the financial system tells a very different story.
- The Great Recession was not a failure of free markets. Rather it was a classic example of the undesirable unintended consequences of government intervention, both through expansionary monetary policy and misguided attempts to bolster the housing market in the USA.
- This combination produced an unsustainable boom in the years following 9/11, with the focus of that boom being a policy-induced asset bubble in housing and the resulting collection of financial instruments built on that bubble.
- Because the boom involved the misallocation of resources due to false interest rate signals, it is proper to characterise the boom as the making of the mistakes and the inevitable bust as their correction.
- The only way to correct that misallocation is to let entrepreneurs guided by market prices, profits and losses figure out where resources now need to go. Government spending programmes are both too