This week we are going to review the tools of monetary policy (the tools the Federal Reserve uses to manage the money supply) and focus on FED’s response to the financial crisis caused by the bursting of the housing market bubble. During the 2007-2009 recession and the following weak recovery years, the Federal Reserve used some unconventional methods to try and stimulate the economy. Normally, the FED only buys US government bonds as part of it’s Open Market Operations and usually it only accepts US government bonds as security for loans through the Discount Window (the Discount Rate is the interest rate for such loans).
However, during the above period, the FED also bought (and accepted as security for Discount Window loans) unconventional (for the FED) assets such as commercial paper and mortgage backed securities. These actions kept those financial markets liquid when otherwise they would have “frozen up” due to a lack of funds going into them. Buying these unconventional assets also increased the money supply very much like normal Open Market Operations would.
At the same time, the FED was using Open Market Operations to purchase very large amounts of US government securities. The FED was buying $85 billion in bonds every month for a considerable period of time (this program ended in the Fall of 2015). These purchases involved an unconventional approach called Quantitative Easing.
Assignment:
- Review the videos above.
- Read Chapter 12 the textbook paying particular attention to the section dealing with the 2007-2009 financial crisis (Section 12.3).
- Undertake additional research as needed. Remember that citations and references are needed.
- In your discussion consider at least the following aspects of the above FED actions:
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- Where they effective in ending the recession and stimulating a recovery in a timely fashion? (For comparison, you may wish to review past business cycle time periods by examining the business cycle data at the .)
- What was the impact on the housing market from the FED’s purchases of mortgage backed securities?
- What is the risk of inflation presented by the huge growth in the monetary supply? What has been the inflationary/deflationary impact(s) of the growth in the money supply so far, if any? (You can find current and historical inflation rates at the website.)
- How does the information you have learned this week, relate to the saving glut topic from week 1? Does this week’s information modify your week 1 views?
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