It is only a year since our over-leveraged system buckled. Fear and panic paralysed normal market functions. What pulled us back from the chasm was the intervention of the Federal Reserve Bank.
The Fed led the way by cutting interest rates aggressively to close to zero. It realised that unconventional policy tools were necessary to keep equity and debt capital flowing, introducing unique lending and asset purchase programmes. The unprecedented measures restored confidence and liquidity without provoking a sharp rise in inflation. The rescue could not have happened without the Fed's credibility and independence from short-term political pressures.
In the process the Fed has stoked public anger by bailing out the very institutions that got us into trouble. By aiding individual firms, the Fed broke its policy of creating moneyonly with reference to the economy as a whole. It had to do this because a general easing would not halt the domino effect whereby one firm's collapse caused a run on others. The Fed's choices were limited to allowing a major institution to fold, raising the prospect of a systemic risk or supporting the institution with taxpayer money. Its choice of the latter course was even braver than in the 1980s when the Fed, in an exemplary illustration of its independence, raised interest rates above 20 per cent and broke the back of the “Great Inflation”. These are a few examples of why we must preserve its ability to foster financial stability.