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During the Greenspan‐Bernanke era, the responses of Federal Reserve officials to financial crises resulted in an extraordinary involvement of the US central bank in the non‐banking financial sector. The purpose of this paper is to examine the informal and evolving conceptual framework that allows Federal Reserve officials to pursue a strategy of “constrained discretion” in responding to financial disturbances.

Behavioural economics relies on designed psychological and economic experiments to predict behavioural biases at the group level. As an analogue applicable to understanding biases in the intuitive judgments of individual policymakers, a naïve behavioural economics approach relies on intuitive or naive psychology and the interpretation of historical events as natural experiments to explain why intuitive judgments of Federal Reserve officials will contain biases.

Under the Greenspan‐Bernanke conceptual framework, Federal Reserve officials exercise “constrained discretion” in responding to disturbances arising from macro structural changes in the financial sector. The two key concepts are the Greenspan‐Bernanke doctrine on how the Federal Reserve officials respond to financial asset price bubbles and their collapses, and Bernanke's financial accelerator. Several examples are cited in which policy errors made by Alan Greenspan were attributable to identifiable biases in his intuitive judgment. In addition, Bernanke's response to the financial crisis of 2007‐2009 was based on his interpretation of the Great Depression as a natural experiment. But that interpretation was heavily biased by the influence of Milton Friedman on Bernanke's intuitive judgment. While Federal Reserve officials will need to exercise discretionary judgment in responding to financial crises, the potential for errors due to biases in that judgment can be reduced through regulatory reforms that lessen the potential for financial crises to occur.

While quantitative analyses of the effects of the Federal Reserve's actions on non‐bank financial institutions and the financial markets are ongoing, little attention has been given to the psychological aspects of the intuitive judgment that influences the discretionary decisions of the policymakers.

In speeches and testimonies, Alan Greenspan claimed intellectual links between his financial policies and the ideas of Milton Friedman and Joseph A. Schumpeter on banks, central banks, and financial crises. As the financial crisis deepened in 2008, Greenspan admitted that his policies had been shockingly wrong. The purpose of this paper is to explain why his claims of intellectual links between those policies and the ideas of Friedman and Schumpeter were also wrong.

Beginning with representative examples of Greenspan's citations of Friedman and of Schumpeter as supporting his financial policies, the authors review the economic ideas of Friedman and Schumpeter on banks, central banks, and financial crises. In each case, we contrast Greenspan's financial policies with those ideas, demonstrating the spurious nature of his claims of intellectual links.

While expanding the role of the Federal Reserve in the financial markets, Greenspan's financial policies were based on the declaration that deregulation and financial innovations were providing flexibility and stability for the entire financial system. In his financial policies, Greenspan rejected Friedman's recommendations for changes in the powers and functioning of the Federal Reserve that featured a monetary policy rule and the 100 percent reserve requirement for deposits that would involve the separation of depository banking from loans and investments. From a Schumpeterian perspective, Greenspan's policies encouraged and facilitated the massive “reckless” finance that was responsible for the financial crisis of 2007‐2009.

Greenspan's legacy as Chairman of the Federal Reserve Board is one of policies that first contributed to recurring financial crises of increasing severity and were then followed by an extraordinary policy expansion of the Federal Reserve in attempts to cope with the crises. On that basis, it is important to have a clear understanding of the lack of intellectual support for those policies from the influential economists with whom he claimed intellectual links.

The purpose of this paper is to develop an analysis of the improbable events of housing market bubbles occurring in a period when US and UK central bankers were responding to perceived risks of a new deflation.

The methodology focuses on how the anti-deflation policies implemented by the Federal Reserve and the Bank of England contributed to the housing market bubbles. The central bankers perceived the deflation as a Keynesian short-run deficiency in aggregate demand, triggered by a financial crisis. Indications are that the deflation is in the nature of long-run aggregate-supply-driven trend as explained in Veblen’s theory of “chronic” deflation driven by cost-reducing advances in technology and globalization.

The Keynesian anti-deflation policies of the Federal Reserve and Bank of England failed to counter the deflation risks while contributing to housing market bubbles. Moreover, the policies failed to address the structural problems of unemployment and income inequality associated with long-run aggregate supply deflation.

Effective policies must be based on a correct theoretical understanding of the problems. The chronic nature of the new deflation points to the need for new approaches to deal with the negative income and employment effects that exclude an increasing number from the housing markets.