This graphs the federal funds rate since1995, the shaded regions correspond to U

Question

This graphs the federal funds rate since1995, the shaded regions correspond to U.S. recessions.

a) Explain why the Fed decreased the federal funds rate during the last two recessions.

b) As you can see from the graph, the Fed raised the federal funds rate in 2004 up to 2006. Again, explain what might have motivated the Fed to act in such a way.

c) As you can also see from the graph, the federal funds rate has been virtually zero since 2009 (with only a small uptick recently which we can ignore here). The Fed would have liked to decrease the rate further but it wasn’t able to do so because the rate cannot become negative. In this situation, the Fed had to resort to other tools to implement its monetary policy objectives. Briefly mention some of these tools.

Explanation / Answer

a) Recession is a duration where real output falls below potential output. Thus to increase output Federal tries various monetray measures such as open marke operation to increase money supply. IN open market operation Federal either sell or buys treasury bonds to/from public. When federal aims to increase money supply its buys treasury bonds from people. People sells funds when the vinterest of funds get decrease thus to motivate them to sell funds, federal decreases funds rate. With such selling money supply will icrease and thus AD will also increasing tending to increase output.

b) There might rise an inflation in economy. Inflation implies increased price level. To reduce price level it was needed to reduce money supply. Hence the federal thus increased the rate so that it can sells funds to public withdrawing some money supply from market.

c) Some other tools of expansionary monetary policy includes lowering bank rate, lowering Statutory liquidity ratio, reducing cash reserve ratio, reducing margin requirement and moral suasion.

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