Question

Give the evidence that monetary policy was too loose prior to the Subprime mortgage crisis and too tight during after the Subprime mortgage crisis.

Answer 1

The best evidence of too loose monetary policy prior to the Sub prime mortgage crisis is excessively low interest rates prior to the Sub prime mortgage crisis which reduced borrowing costs, inducing financial institutions to over leverage their balance sheets in pursuit of returns. This led to having riskier assets in the portfolio and thus low interest rate is cited as one of the reasons of the Sub prime mortgage crisis. However, after and during the Sub prime mortgage crisis the monetary policy was suddenly tightened to reduce money supply to increase the cost of borrowing and this led to fall in holding riskier assets.

Thus, movements in the interest rates are the best evidence of too loose monetary policy prior to the sub prime mortgage crisis and too tight during after the Sub prime mortgage crisis.