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The Nobel Prize—winning economist Milton Friedman once likened monetary policy to throwing money from a helicopter. Thus, when Business Week asked in 2008, “Will ‘Helicopter Ben’ Ride to the Rescue?” they were asking whether Ben Bernanke, then the chairman of the Federal Reserve, would be able to use monetary policy to jolt the economy out of a looming recession.

In reality, the Federal Reserve rarely uses helicopters in its rescue operations. As discussed in Chapter 34, the Fed uses three primary tools to influence aggregate demand (AD), namely (1) open market operations in which the Fed buys bonds, which increases the money supply and reduces interest rates, or the Fed sells bonds, which decreases the money supply and increases interest rates; (2) lending to banks and other financial institutions; and (3) changes in the interest rate paid on reserves. These are the essential methods through which the Fed affects the real economy.

In this chapter, we take for granted how the Fed influences AD and turn more directly to three key practical questions: When should the Fed try to influence AD, when will the Fed be able to influence AD, and when will the influence on AD result in higher GDP growth rates?

We start with the best case for monetary policy: where it is clear what the Fed should do in general terms, such as responding to negative monetary shocks, and when the Fed has a good chance of being successful. We then consider some reasons why even in the best case the Fed doesn’t always know which detailed course of action is best. We next consider why some of the other cases—such as negative real shocks—are much harder for the Fed to respond to effectively. Finally, we learn that there are some times when the Fed itself can contribute to a boom and subsequent bust. We end with a look at the financial crisis that started in 2007.

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