In a response, address the following: - What actions can the Fed take to conduct

Question

In a response, address the following:

- What actions can the Fed take to conduct monetary policy? What are some of the effects we would expect to see from contractionary or expansionary monetary policy?

- Now do some research and find any case of monetary policy action that the Fed utilized in the past 10 years and explain what purpose the Fed had in conducting that monetary policy action. What economic effect do you feel we saw from that monetary policy action? Do your best to avoid posting duplicated examples and information if possible.

Explanation / Answer

ans...
Monetary policy is the policy of the central bank of an economy that has clear macroeconomic goal of maintaining equilibrium in the money market and therefore assist the economy in realizing its fundamental goals. In the United States the Fed carries out monetary policy. There are three main policy tools of the Fed:
a) The discount rate
The discount rate is the interest rate the Fed charges on loans that it makes to banks. If the Fed wants to lower the money supply, it increases the discount rate. Higher the discount rate, less encouragement will the banks get to borrow from the Fed. When the borrowing is reduced, the Fed, the amount of loan granted is reduced in tandem and so the money supply reduced.
b) Reserve requirements
Higher reserve requirements would reduce the bank profits as it limit the amount of loans they can grant. It is just like a tax. The lending capacity will be reduced and so the money supply will fall.
c) Open market operations
Open market operations is the process of the buying and selling of government securities by the Fed in the open market. When the Fed has an aim to reduce the money supply, it enters the money market and sells government securities. Currency in circulation, deposits all are reduced and through the multiplier effect, money supply is reduced.
If the Fed is adopting an expansionary monetary policy right at the end of recession, it will overstimulate the economy. This will result in high inflation. Similarly, a contractionary monetary policy applied right during the recovering phase can slow down the process of expansion. A term called ‘Premature tightening’ has been used in this case in order to depict the adoption of a tight monetary policy before its apposite time.
Quantitative easing as a unique monetary policy
During the financial crisis of 2007-2009, the Fed decided to implement the policy of Quantitative Easing commonly written as QE. Due to financial pessimism, most of the commercial banks were reluctant in lending out their reserves so they piled up and households and firms curtailed their expenditure.
It was at this time, that the Fed conducted its open market operations to buy short term financial instruments in order to keep the interest rate stable (prevented it from rising). It was buying mortgage-backed securities. The aim was to keep the interest rates on most types of the loans low so that the demand for housing is stimulated. The Fed was buying long term securities to further liquidate the market. These measures indicate that the Fed was channeling through a wider spectrum of interest rates and was not targeting one specific rate of interest.

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.