History has shown that the price of economic stability is usually economic stagnation. The price for economic growth is allowing for “creative destruction” which breeds a certain level of instability. Stability and predictability are the enemies of dynamism, and countries which seek them ultimately pay with slower economic growth. Until recently it seemed impossible to have both a dynamic economy with strong growth and a stable economy with relative predictability and security.

During the “great moderation” it seemed that we could have our cake and eat it too—dynamic economic growth and relative stability and predictability in the economy. It seemed that the Federal Reserve had found the magic formula for sustaining economic growth while avoiding serious dislocations in the economy.

But now it seems that the very success of these policies imposed an unseen cost—the creation of a new kind of moral hazard. The very success of the Fed invited investors to assume that economy could bear almost any shock and keep right on humming, as it had during the financial crises that hit during this 25 year period. The apparent success of the Fed in moderating economic swings seemed to mean reduced risk for investors. The apparent reduction in risk in turn fed an appetite for what in earlier times seemed to be high-risk investments.

Risk, it appeared, had begun to disappear from the financial system. Everybody believed that the Fed knew how to keep the economy humming and ensure that crises could be turned into mere hiccups. Even a crisis as severe as the dot com bubble in which $5 Trillion of wealth evaporated only triggered only a mild recession.

Viewed in this light, the seemingly successful policies of the past few decades helped set us up for the severity of the crisis we face today. The excessive risk-taking of the past decade was spurred on by the success of the Fed in moderating the costs to the economy of prior crises. The Fed’s earlier successes have led us to the current morass.

Unsurprisingly there turns out to be no magic bullet for eliminating the business cycle. Even a period of successful Fed management of the economy has its own potential dangers, the fruits of which we are seeing today. We can only hope that the tools the Federal Reserve and Treasury have at their disposal are up to the task of keeping our economy afloat as it works through the effects of the excessive risk-taking of the past quarter century.