Macro

CTW2

David Gijon

Georgia State University

7/21/2014

1. Monetary policies in the wake of the Financial Crisis of 2008

The initial response of the Federal Reserve Bank of America was in the form of cutting interest rates by 50 basis points. With the realization the financial hardship was still persistent across the nation, the Federal Open Committee moved in to reduce the (FFR) Federal Funds Rate, which originally stood at 5.25%. The new rate was now 2 percent. This reduction was carried out in the period between September 2007 and April 2008 (Thornton, 2010). Additionally, the basic lending rate was brought down to 25 basis points. This was also followed by the introduction of Term Auction Facility. At a significant level the Fed has historically contracted or expanded its balance sheet through its investing and lending activities. The effect of these monetary policies was to expand or contract the monetary base as well as the supply of credit. Considering the banking system structure, as well as, the reserve requirements; changes in monetary base are aimed at altering the money supply. The effect on the supply of money is the manner in which the Fed influences the interest rates (Thornton, 2004). This brings about the liquidity effect which is characterized by a high supply of money and reduced interest rates. Despite the fact that the demand for money may not be necessarily influenced by interest rates the lending and investing activities of the Fed affect the availability of credit. One instance where such monetary policy was used by the Fed is in the aftermath of the Lehman Bros collapse. In what was termed as quantitative easing 1, the Fed purchased securities backed by mortgages, agency debt and long term treasuries. This was followed by quantitative easing 2 QE2 whereby further long term treasuries were purchased (Joyce et al., 2010). These measures by the Fed were aimed at increasing aggregate demand through a reduction of long term yields. Sadly the QEs did not achieve the desired long term yields as the Feds had anticipated. Generally, borrowing too did not pick up as had been anticipated in the increase of credit supply.

2. Fiscal policies after the financial melt down

The reasonable thing to do in the event of a financial crisis is to induce aggregate demand. There exists a disagreement on the manner in which aggregate demand can be expanded. Government spending is one of the commonly used fiscal policies: it is usually aimed at reversing the effects of recessions such as unemployment, loss of benefits, and decline in tax revenues, which stem from the decline in the economic activities. On the same note other discretionary measures such as tax rates reduction or tax holidays on businesses and households can be used to quicken the economic recovery. The government would also try to offer loans to states and firms as well as, grants and contracts for investment. These were the fiscal tools employed by the federal government in the wake of the financial crisis of 2008. The government employed several government expenditures which are rare countercyclical measures. The first initial government expenditure was used by G.W. Bush in the purchase of huge non-performing financial assets from banks on the verge of collapse. These activities are considered fiscal because for purchase of such private liabilities by the fed must be approved by the congress. In a budget funded by the congress at a cost of $700 billion the treasury bought the assets from the troubled banks. This initiative was known as Troubled Asset Relief Program (TARP). Through the TARP initiative funds were induced into the ailing corporations such as GM , AIG and Citigroup. The underlying idea was to strengthen banks’ balance sheet with an aim of inducing the flow of credit easily to finance investments. Another fiscal action taken by the government was the ARRA (American Recovery and Reinvestment Act) of 2009. This approach appropriated $787 billion in terms of tax cuts, as well as benefits to firms and individuals. The government also used other measures such as TANF (Temporary Assistance to Needy Families) program in conjunction with other emergency funds (Gali, Lopez-Salido & Valles, 2005). The ARRA and TANF were positive measure but sadly only comprised 10 percent of the GDP. Additionally, the measures had a small impact as they were inadequate when it comes to direction and size. The programs had insignificant contribution to the recovery of the economy perhaps due to their small size.

3. Further steps the Federal reserve/government cab stimulate the economy.

The Federal Reserve achieves its target by controlling the interest rates when inflation goes up and when the economy is struggling. This move aims at controlling the supply of money in the economy. FFR (Federal Funds Rates) are some of the tools the Federal Reserve uses to control the supply of money. Federal Funds Rate is the charged on inter-bank borrowing. This borrowing occurs between banks with excess reserves and those with a shortage in the authorized reserves (Alesina & Giavazzi, 2013). The interest charged on such borrowing is called Federal Funds Rate which is controlled by the actions of reserves demand and supply. Regulation of the funds rate is a sure way to improve the economy.

Good description of monetary and fiscal policies. Needs to include policy recommendations, applications of a model, introduction, and conclusion. Grammar is pretty good, needs proofreading.

References

Gali, J. Lopez-Salido, D. and Valles, J. (2005). “Understanding the Effects of Government Spending on Consumption,” CREI.

Joyce et al., (2010). “The Financial Market Impact of Quantitative Easing,” Bank of England Working Paper 393.

Thornton, D.L. (2010c). “Monetary Policy and Longer-Term Rates: An Opportunity for Greater Transparency,” Federal Reserve Bank of St. Louis Economic Synopses, No. 36.

Thornton, D.L. (2004). “The Fed and Short-term Interest Rates: Is It Open Market Operations, Open Mouth Operations or Interest Rate Smoothing?” Journal of Banking and Finance, 28(3), 475-98.

Alesina, A., & Giavazzi, F. (2013). Fiscal policy after the financial crisis. University of Chicago Press: Chicago.

�Which one? Apply a model from the book

�What?

�How would this work? Use a model

�Different bailout

�Not enough detail. Evidence? Apply the policies to a model

�Target what?

�Doesn’t this belong in the monetary policy section? You talked about how the Fed already used this tool