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The Federal Reserve's interest rate policy was insufficient, on its own, to achieve the Federal Reserve's goals during the recent financial crisis. Acquiring the legal authority to pay interest on reserves allowed the Federal Reserve to implement monetary policy using a floor system and thereby divorce interest rate policy from balance sheet policy. Although the floor system entails immediate benefits, such as eliminating the implicit tax on reserves and reducing the credit risk associated with daylight overdrafts, the remote effects include potentially large costs. More specifically, the Federal Reserve's balance sheet policies may reduce longer-run economic growth and risk the institution's independence. To maintain the floor system's present benefits, the Federal Reserve should therefore continue to implement interest rate policy through interest on reserves. To protect against the floor system's future costs, the Federal Reserve should, however, restrict its balance sheet policy to Bagehot's principles for lastresort lending.

The consensus that financial intermediaries do not independently affect the real economy existed among macroeconomists during the second half of the twentieth century. Changes in the supply of credit were therefore irrelevant to understanding business cycles. The recent U.S. financial crisis, however, put a spotlight on the independent role financial intermediaries can play in generating and amplifying business cycles. To explore that role further, this dissertation examines empirically whether transmission of shocks to the real economy occurs through changes in the supply of credit and, if so, by which mechanisms, during which periods of time, and under what conditions. To the extent that changes in the supply of credit affect economic activity, results shed light on how to implement monetary policy more effectively going forward. Chapter One considers whether a credit supply variable provides consistent and stable information, beyond that of real interest rates and the money supply, about future changes in the output gap during the U.S. post-war era. Results yield evidence that changes in the supply of credit do provide information about future changes in the output gap, yet that relationship is neither consistent nor stable. Changes in the supply of credit are, however, the only variable among those considered that offers information about future changes in the output gap during the twenty-first century. Chapter Two examines the timing and extent to which financial factors contributed to the Great Depression through changes in the supply of credit. Results illustrate that disruptions of financial intermediation, through changes in the supply of credit and the cost of capital, were a primary mechanism for the propagation, amplification, and extension of shocks throughout the Great Depression. Findings therefore suggest that conventional monetary policy would have been insufficient to offset the decline in output due to financial factors. Chapter Three considers whether the relationship between the supply of credit and the real economy changed over time and under different credit market conditions during the U.S. post-war era. Results yield evidence that a quantitatively important relationship between the supply of credit and real economic activity existed during the entire era and separate from periods of financial stress. Findings, however, also offer evidence that the indirect effect of changes in the supply of credit on real economic activity, operating through their effect on macro risk premia, became quantitatively more important during periods of financial stress in the twenty-first century. The overall conclusion is that transmission of shocks to the real economy occurred through changes in the supply of credit throughout U.S. history. The economic significance of specific mechanisms, however, shifted over time due to changes in the structure of credit markets and financial institutions. The Federal Reserve therefore may benefit from permanently expanding its set of indicator variables and monetary policy toolkit.

The Federal Reserve's interest rate policy was insufficient, on its own, to achieve the Federal Reserve's goals during the recent financial crisis. Acquiring the legal authority to pay interest on reserves allowed the Federal Reserve to implement monetary policy using a floor system and thereby divorce interest rate policy from balance sheet policy. Although the floor system entails immediate benefits, such as eliminating the implicit tax on reserves and reducing the credit risk associated with daylight overdrafts, the remote effects include potentially large costs. More specifically, the Federal Reserve's balance sheet policies may reduce longer-run economic growth and risk the institution's independence. To maintain the floor system's present benefits, the Federal Reserve should therefore continue to implement interest rate policy through interest on reserves. To protect against the floor system's future costs, the Federal Reserve should, however, restrict its balance sheet policy to Bagehot's principles for lastresort lending.