Question 2

Part (50 poims) The financial crisis

When the housing bubble burst, it had a devastating effect on the economy, causing the financial crisis and the Great Recession. Many argue that the Fed should stop asset bubbles when they start forming and before they burst. Discuss the pros and cons of the Fed intervening in such situations.

Your answer should not be more than 800 words (there is a 10% penalty if you exceed this

limit).

In your answer, you must touch on the following topics:

1. identification of the bubble

2. how the Fed can react to a bubble

3. cost/benefit analysis of the Fed reaction to a bubble

4. few recommendations to make the financial system more resilient to bubbles.