3) Assume in parts (a) –(c) that the Fed has decided that a slow (50 basis point

Question

3) Assume in parts (a) –(c) that the Fed has decided that a slow (50 basis points per year) rise in the Federal funds rates is likely the correct approach to balancing risks of holding inflation to around 2% per year while maintaining enough growth in GD and labor markets to archive and stay at full employment. However, even if this is the correct view, it may not be the view that financial markets, lenders and CEO’s take. (Hint: read the material on policy normalization on the Federal Reserve website under the tab “monetary policy”)

a) What problems might arise in controlling the Federal Funds rate and money market short term rate s to keep them in the Fed’s target zone as the Fed slowly raises that target zone given the fact that in the aftermath of QE1 through Qe3, most banks hold substantial excess reserves?

b) How will the Feb’s ability to pay interest on bank reserves help it deal with these potential problems?

c) How will short term repo market sales of treasury securities from the Fed’s balance sheet help it keep money market interest rates and yields within the Fed’s fed fund target range as the Fed increases its Fed funds target?

Explanation / Answer

(a) The problems which might arise in controlling the Federal Funds rate and money market term rate to keep them in the Fed's target zone is lack demand and supply in the market. It happens due to market failure.

(b) THe Fed's ability to pay interest on bank reserve could be resolved if trade increases. The rate of interest is kept high to earn from taxes of the government.

(c) The short term repo market sales of treasury securities from the Fed's balance sheet could help in keeping money interest rates and yields with in Fed's fund target range as the Fed increases Fed funds target. It could happen when there is an increase in the revenues fromt he market. The market has to increase the efficcieny in outputs. The revenues are earned on the basis of high implementation of policies in the market.

Related Questions

Navigate

• Browse (All)
• Browse 3
• Subjects

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