New York Fed Research Finds Major U.S. Monetary-Policy Improvements Came Only in Recent Decades

The Federal Reserve’s approach to economic shocks did not steadily improve over more than a century of U.S. monetary history, according to research discussed by the Federal Reserve Bank of New York on Monday. The researchers found that the most substantial gains appeared in the 1990–2019 period, after decades in which monetary policy frequently diverged from the best response available at the time.

The study points to two changes above all: a better response to financial crises and a stronger reaction to shocks that threaten price stability. Its conclusions concern the effectiveness of policy decisions under the circumstances policymakers faced, not whether one period happened to have lower inflation or unemployment than another.

Regis Barnichon, a researcher at the San Francisco Fed, and Geert Mesters, a researcher at the New York Fed, developed the framework. Their findings were presented in a November 9 Liberty Street Economics post summarizing a research paper that had circulated previously and is listed as forthcoming in the journal Econometrica. The analysis covers historical periods ending in 2019, so it does not evaluate the Federal Reserve’s decisions during the pandemic or in subsequent years.

A test of policy decisions, not favorable economic conditions

The authors’ central question is how to tell sound monetary policy apart from good luck. A central bank can produce relatively stable outcomes if the economy encounters only mild disturbances, even when its decisions are imperfect. Another can struggle through a banking panic despite taking more appropriate action. In their New York Fed analysis, Barnichon and Mesters compare the path of policy with the best feasible response to the shocks that actually occurred.

Rather than relying solely on the observed inflation rate or unemployment rate, they estimate how those outcomes responded to monetary-policy actions and to shocks outside policymakers’ control. The resulting comparison assesses the policy reaction itself. One measure asks how much the interest-rate response would have to change to reach the estimated best feasible path; another estimates the avoidable macroeconomic losses associated with departures from that path.

The distinction matters because the historical episodes were hardly comparable on the surface. The study examines the pre-Fed gold-standard years from 1879 to 1912, the early Federal Reserve from 1913 to 1941, a postwar period that includes the Great Inflation, and the post-Volcker period from 1990 to 2019. The first period predates the Federal Reserve’s creation. Each era faced different institutions, pressures and economic disturbances.

According to the researchers, the estimated average adjustment needed to correct policy’s reaction to shocks exceeded 100% in the three earlier eras. It was around 30% in 1990–2019, with the estimated corrections for that later period statistically insignificant. These percentages measure adjustments to modeled policy responses, not percentage changes in actual interest-rate levels. The finding challenges the idea that monetary-policy competence improved gradually with every new generation of central bankers.

Banking panics reveal the early Fed’s policy errors

Financial distress offers the clearest contrast. In the early Federal Reserve years, the researchers found that adverse banking shocks tended to be followed by higher policy rates. Because those shocks also pushed inflation down, the real interest rate, which accounts for inflation, rose even more. The effect was to tighten monetary conditions when the economy was already under strain.

Their counterfactual exercise suggests that lowering rates in response to those shocks would have done more to stabilize both inflation and unemployment. This is not a claim that every banking failure could have been prevented. It is a comparison between the average response the researchers estimated and a more effective response within their framework.

Historical accounts also show that the Fed did not behave uniformly during the banking panics of the early 1930s. Federal Reserve districts differed in their willingness to extend credit during episodes of financial stress, with some providing emergency lending more readily than others. The researchers’ study adds a broader quantitative assessment of how policy responded to such disruptions.

For 1990–2019, the pattern changes. After negative financial shocks, the Fed’s estimated response generally involved lowering rates rather than raising them. The authors found relatively small, statistically insignificant differences between those responses and the modeled optimum, as well as much smaller avoidable losses than in the early Fed period. They identify improved handling of financial shocks as one of the principal sources of the later gains.

The Great Inflation exposed a different weakness

The postwar period showed problems of another kind. In the researchers’ assessment, the Fed did too little in response to disturbances linked to energy prices, productivity and inflation expectations. The concern was not primarily a failure to ease policy during financial panics, but a failure to lean hard enough against shocks capable of keeping inflation elevated.

When inflation expectations rose, the study finds, nominal policy rates reacted too weakly. That allowed inflation-adjusted interest rates to decline, adding to inflation pressure instead of containing it. The researchers estimate that a stronger interest-rate response would have brought policy closer to its best feasible course. Their result is consistent with the principle that interest rates generally need to rise sufficiently when inflation pressures intensify.

This interpretation fits part of the historical record. The Federal Reserve’s account of the Great Inflation describes a period running from 1965 to 1982, when U.S. inflation climbed from low levels in the mid-1960s to more than 14% in 1980. Oil disruptions contributed to the difficult environment, but monetary-policy choices also played a central role. The episode reshaped how central bankers thought about inflation expectations and their credibility.

Paul Volcker became Fed chair in 1979 and pursued policies aimed at bringing inflation down, even as the economy endured serious recessions. The study finds substantially better systematic responses in the later sample, but its results should not be read as assigning every improvement to one official or one decision. The comparison is between estimated policy behavior across different eras, rather than a simple before-and-after scorecard for Volcker’s tenure.

What the historical finding does not establish

The study’s claim is narrower than a blanket judgment that the Federal Reserve has always made good decisions since 1990. An estimated policy response can be closer to a modeled optimum without eliminating recessions, banking stress or inflation. The researchers are evaluating how policy reacted to identified shocks, not promising that the economy could have been stabilized perfectly.

Its method also depends on estimates of how the economy responds to different disturbances. The best feasible policy is a counterfactual benchmark calculated from those estimated relationships; it is not an alternative history that anyone can directly observe. That makes the framework useful for testing a longstanding historical question, but it does not remove uncertainty from judgments about policy.

Most importantly for current debates, the last sample ends in 2019. The findings do not provide a verdict on the pandemic-era inflation surge, the subsequent interest-rate cycle or the Federal Reserve’s policy decisions in 2026. The New York Fed publication also notes that the conclusions are those of the authors, not necessarily the official views of the New York Fed or the Federal Reserve System.