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Intuitive psychology, natural experiments, and the Greenspan-Bernanke conceptual framework for responding to financial crises


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  • Charles G. Leathers
  • J. Patrick Raines
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    Purpose – During the Greenspan-Bernanke era, the responses of Federal Reserve officials to financial crises resulted in an extraordinary involvement of the US central bank in the non-banking financial sector. The purpose of this paper is to examine the informal and evolving conceptual framework that allows Federal Reserve officials to pursue a strategy of “constrained discretion” in responding to financial disturbances. Design/methodology/approach – Behavioural economics relies on designed psychological and economic experiments to predict behavioural biases at the group level. As an analogue applicable to understanding biases in the intuitive judgments of individual policymakers, a naïve behavioural economics approach relies on intuitive or naive psychology and the interpretation of historical events as natural experiments to explain why intuitive judgments of Federal Reserve officials will contain biases. Findings – Under the Greenspan-Bernanke conceptual framework, Federal Reserve officials exercise “constrained discretion” in responding to disturbances arising from macro structural changes in the financial sector. The two key concepts are the Greenspan-Bernanke doctrine on how the Federal Reserve officials respond to financial asset price bubbles and their collapses, and Bernanke's financial accelerator. Several examples are cited in which policy errors made by Alan Greenspan were attributable to identifiable biases in his intuitive judgment. In addition, Bernanke's response to the financial crisis of 2007-2009 was based on his interpretation of the Great Depression as a natural experiment. But that interpretation was heavily biased by the influence of Milton Friedman on Bernanke's intuitive judgment. While Federal Reserve officials will need to exercise discretionary judgment in responding to financial crises, the potential for errors due to biases in that judgment can be reduced through regulatory reforms that lessen the potential for financial crises to occur. Originality/value – While quantitative analyses of the effects of the Federal Reserve's actions on non-bank financial institutions and the financial markets are ongoing, little attention has been given to the psychological aspects of the intuitive judgment that influences the discretionary decisions of the policymakers.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal International Journal of Social Economics.

    Volume (Year): 39 (2012)
    Issue (Month): 4 (March)
    Pages: 281-295

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    Handle: RePEc:eme:ijsepp:v:39:y:2012:i:4:p:281-295

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    Postal: Emerald Group Publishing, Howard House, Wagon Lane, Bingley, BD16 1WA, UK

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    Keywords: Behavioural economics; Economic policy; Financial accelerator; Greenspan-Bernanke doctrine; Intuitive psychology; Naïve behavioural economics; Natural experiments; United States of America;


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    1. Alan Greenspan, 1999. "Opening remarks : new challenges for monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 1-9.
    2. Ben Bernanke & Mark Gertler, 2000. "Monetary Policy and Asset Price Volatility," NBER Working Papers 7559, National Bureau of Economic Research, Inc.
    3. Etzioni, Amitai, 2010. "Behavioral economics: A methodological note," Journal of Economic Psychology, Elsevier, vol. 31(1), pages 51-54, February.
    4. Milton Friedman, 2005. "A Natural Experiment in Monetary Policy Covering Three Episodes of Growth and Decline in the Economy and the Stock Market," Journal of Economic Perspectives, American Economic Association, vol. 19(4), pages 145-150, Fall.
    5. Mishkin, F S., 2008. "How should we respond to asset price bubbles?," Financial Stability Review, Banque de France, issue 12, pages 65-74, October.
    6. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May.
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