We provide an overview of the monetary policy failures that resulted in the 2007–2008 financial crisis and ensuing Great Recession, focusing on the United States. Before the crisis, monetary policy was too loose, which fueled the bubble. After the bubble burst, monetary policy became too tight, hindering the recovery. These failures are fundamentally due to the Federal Reserve’s discretionary monetary policy. Furthermore, the popular approach of “constrained discretion” is really just discretion. Hence, it is sensitive to all the usual problems with discretionary monetary policy. Only firm monetary rules, ones that actually bind, can maintain macroeconomic stability and prevent crises.

Financial crises are widely perceived to be the reason monetary rules cannot work. The extraordinary challenges posed by crises require policymakers to act discretionarily. We show that this argument is not only wrong but backward: It is more important than ever to have true rules for monetary policy, which actually bind, to cope with financial crises. We show how the Fed failed to respond appropriately to the 2007–2008 crisis. Contrary to the then chairman Bernanke’s public statements, the Fed did not behave as an orthodox lender of last resort. Instead, it experimented with dubious policies that further entrenched moral hazard in the financial system. We criticize these policies, as well as an approach to economics, which we call “triage economics,” that mistakenly supposes the basic rules of price theory provided no guidance in crafting policy responses to crises. A rules-based approach to monetary policy is thus consistent with extreme market turbulence. In fact, rules are how such turbulence is pacified.