Unconvetional Monetary Policy a) What are the unconventional monetary tools? Why
ID: 2753341 • Letter: U
Question
Unconvetional Monetary Policy
a) What are the unconventional monetary tools? Why do we need these unconventional tools?
b) According to Arvind Krisnamurthy and Annette Vissing-Jorgensen, what are the channels that make QEs effective in affecting the prices of purchases assets? in stimulating the real economy?
c) According to Arvind Krisnamurthy and Annette Vissing-Jorgensen, what is the order in which the Fed should unload the assets, accumulated from large-scale asset purchases program during and after the financial crisis of 2007-2009, in its balance sheet (treasuries, agency mortgage backed securities) when the economy recovers from the crisis? Why?
Explanation / Answer
Unconvetional Monetary Policy
a) What are the unconventional monetary tools? Why do we need these unconventional tools?
When a nation's economy becomes 'overheated' – growing rapidly to the point that inflation increases to dangerous levels – the central bank will enact restrictive monetary policy to tighten the money supply. This effectively reduces the amount of money in circulation and also the rate at which new money enters the system.
When a nation's economy slips into recession, these policy tools can be operated in reverse, constituting a loose or expansionary monetary policy. Interest rates are lowered, reserve limits loosened, and instead of selling bonds in the open market, they are purchased in exchange for newly created money.
Tools of monetary policy:
Conventional methods used to exercise monetary policy include increasing or decreasing target interest rates, bank reserve limits, and the money supply itself through open market operations.
2- According to Arvind Krisnamurthy and Annette Vissing-Jorgensen, what are the channels that make QEs effective in affecting the prices of purchases assets? in stimulating the real economy?
According to Arvind Krisnamurthy and Annette Vissing-Jorgensen : Quantitative easing (QE) is thought to work by reducing expected future short-term policy rates and the supply of long-term bonds. This column argues that a third channel may be at work, namely a reserve-induced portfolio balance channel. It operates through the increase in central bank reserves on commercial banks’ balance sheets and is independent of which assets the central bank purchases. Central banks can implement QE programmes through purchases of other assets than long-term bonds and still reduce long-term yields.
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Economists largely agree that QE has raised asset prices, including equity prices, and affected economies positively. For this reason, the IMF has recommended aggressive QE, including purchases of government bonds, by the ECB. Moreover, there is some evidence that these effects, too, are strongest via the signalling channel, probably because QE was seen to cut off the tail risks of a still deeper slump
QE has then proved itself to be a useful instrument under slump conditions. That is the view of most policy makers and academics. It is not universally shared: complete agreement on policy is impossible.
3- According to Arvind Krisnamurthy and Annette Vissing-Jorgensen, what is the order in which the Fed should unload the assets, accumulated from large-scale asset purchases program during and after the financial crisis of 2007-2009, in its balance sheet (treasuries, agency mortgage backed securities) when the economy recovers from the crisis? Why?
Teasury will first because it will increase the liquidity in the market via banking channel and system and secondly by agency mortaged backed securities
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