John Taylor from Stanford University has argued that the Fed s easy money policy from mid-2001 through 2004 was largely responsible for the housing boom in the decade that ultimately caused so much financial damage. Taylor used his own model of monetary policy the Taylor rule to analyze the Fed s behavior. In his prior work, he demonstrated that the Fed s behavior could be closely described by a model that allowed for some monetary policy tightening and easing in response to output movements. Applying this model to the decade of 2000, however, Taylor found that, compared to past experience, the Fed was much too aggressive in lowering interest rates. Interest rates fell from 2 percent in mid-2001 to 1 percent by 2004. Past experience, however, would have suggested that the Fed would have raised interest rates to 4 percent by 2004 a very significant deviation.
Taylor then showed that housing starts which are very sensitive to interest rates would have been much lower if the Fed had not followed its easy money policy. The boom and bust would have been avoided. Finally, as an additional piece of evidence, Taylor looked at the experiences of European countries. There the same phenomenon occurred. Countries that deviated most from the Taylor rule for example, Spain experienced the worst boom and bust cycles for housing