Research Paper on "Fed's Response to 2008-09 Recession"

Research Paper 9 pages (3043 words) Sources: 7

[EXCERPT] . . . .

There is a hiring intentions survey that can also hint at the future for employment.

Unemployment is always worth a little context, because it is influenced by changes to both the numerator and denominator. So the Fed needs to not only look at the unemployment number, but the total number of jobs created in the economy, in order to evaluate where employment is heading. The inflation rate is more about the core CPI than the headline number. Any time an individual number skews the CPI, the Fed has to have the breakdown of the number to show that, so it can evaluate the inflation rate in more intelligent terms. In essence, each indicator can be broken down into more refined detail, to give the Fed a better picture not only of where the economy currently stands but where it might stand in the future as well.

Monetary Policies

The Fed influences the money supply via three different types of monetary policy -- open market transactions, the Fed funds rate and reserve requirements. The most commonly-used form is the open market transaction. The Fed buys or sells Treasury securities in order to directly put money into the economy, or take money out of the economy. The money flows into the economy via the major investment banks, which must invest that money. Thus, today, open market transactions may be relatively inefficient compared with decades past, because money flowing into U.S. corporations can be invested anywhere in the world. This is why, perhaps, the stock market has increased so much faster than the GDP has grown. The GNP might confirm whether this is what is happening -- should it have increased at a faster rate than the GDP over the past several years. As noted above, quantitative easing is essentially an open market transaction based on longer-term Treasury securities.

The second mechanism by which the Fed exerts monetary policy is through the Fed funds rate. This mechanism does not directly put money into the economy, but it lowers the cost of money to banks, which should pass along the lower rates to borrowers. With lower rates, borrowers should be able to invest in more projects, assuming that there are projects worthwhile in a slow-growing economy. The growth rate today, while fairly slow, is nevertheless steady. The issue with the Fed funds rate as a mechanism for spurring growth today is that the rate is already at very low levels. With the rate up against the zero bound, there is no meaningful way for the Fed to lower rates any further, other than to announce that the rates will remain low for the foreseeable future, a tactic the Fed utilized with some frequency as the economy was just coming out of the recession and there were concerns about an overheated recovery.

The Fed seldom turns to reserve requirements, which are the amount of money that banks need to hold back from their deposits. The higher the reserve requirements, the less money is in the economy . Changing the reserve requirements is the most disruptive to the economy, especially when they are tightened. Tightening the reserve requirements would require the banks to call in loans, which would be hugely disruptive to the economy. Thus, the Fed has historically been reluctant to loosen the reserve requirements as a mechanism of monetary policy, because of how difficult it would be to reverse such a move. This is basically a 'desperate measures for desperate times' approach, and was not used to deal with the past recession.

Overall, the Fed has expended much of its potential means to spur economic growth. Interest rates cannot be lowered further, and loosening the reserve requirements would require the Fed to have a long-term commitment to keeping the loose. Thus, open market transactions are the primary means by which the Fed will seek to improve the economy. The Fed can, at this point, only continue on its current course, and commit to that, in order to spark further economic growth. At this point, improving growth rates might require fiscal policy or trade policy changes. Otherwise, with slow but steady growth coupled with falling unemployment and inflation below the Fed's target threshold, there is little need to make changes to the current monetary policy.

Monetary vs. Fiscal Policy

The near-exclusive use of monetary policy to manage the economy in recent years reflects one of monetary policy's greatest strengths -- it can be done quickly, by professional economists, and is not subject to Congressional interference. This is good, given that Congress is typically filled with people who know nothing about economics, can be ideologues and are usually block voters. Congress has proven entirely ineffective at implementing useful fiscal policy, and has not acted using evidence-based practice. The freedom from oversight may be seen by some as negative, but when the people doing the overseeing are not even remotely qualified to do so, avoiding Congressional oversight is a significant advantage for monetary policy.

The major downside of monetary policy is that it has its limits. Interest rates can come against the zero bound. Expansionary monetary policy via open market transactions is powerful, but there are limits to this power. Putting money into the banking system is not directly putting money into the money supply. The banks have to be willing to lend the money, and that means that there needs to be borrowers who will invest that money in America. If the banks do not lend, borrowers do not borrow, and any money that is lent out is invested overseas, the likely outcome is that the money will not translate to economic growth as efficiently as envisioned. It is worth remembering that capital can travel globally much more easily than ever before, so additional capital available to U.S. corporations may benefit the stock market a lot more than it benefits the U.S. economy overall, if the money is ultimately invested overseas.

Thus, fiscal policy is more powerful than monetary policy, though its usefulness is dependent on where it is targeted. Fiscal policy unfortunately is just a lot more difficult to implement. It is not always as difficult to implement as it has been the past few years, but it can be, and thus is not necessarily reliable as a means of sparking economic growth. Both fiscal and monetary policy can help promote economic and price stability, but while fiscal policy is more powerful, monetary policy is easier to implement. That said, there are many ways for fiscal policy to contribute, but monetary policy only works in a couple of different ways, making it a more limited option for achieving economic stability.

AD/AS

If the Fed engages in open market transactions, such actions increase the supply of money in the economy, thereby theoretically lowering its price. Aggregate supply increases, which makes it easier for firms to acquire the capital that they need to invest in growth opportunities. Thus, open market transactions are a means by which supply can be increased in the economy.

The Fed funds rate affects demand more than supply because it lower rates should spur more borrowing. This works because more projects are viable when rates are lower. A lower cost of money thus means that there is more incentive for companies to invest because their cost of capital will be lower.

The reserve requirements likewise increase the supply in the market. Basically, when supply is increased, it will either soak of latent demand that could not be filled, or if there was no such latent demand, the increased supply should reduce the cost of money. A lower cost of money should increase demand, resulting in an new equilibrium point, one with higher levels of demand.

Conclusion

There are three main means by which the Fed conducts monetary policy. In recent years, a lack of fiscal policy has forced the Fed to take a bigger role that it might otherwise prefer, including extending its open market transactions to longer-term Treasury securities. The evidence shows that there are limits to what monetary policy alone can do for managing the economy. In particular, with interest rates against zero for many years, the economy is still growing relatively slowly, while the stock market has more than doubled. This illustrates that there may be inefficiencies somewhere in the system that maybe were not there before -- like the ability for American corporations to take capital that originates from the Fed and invest it overseas. The link between money supply and economic growth is simply not as tight as it once was. But overall, the economy is still growing (albeit slowly), interest rates are stable and unemployment is slowly falling. While there remains risk going forward the economy is in a stable position for now, and that is due to the work that the Fed has done over the course of the last several years.

References

BEA (2015). Gross Domestic Product. Bureau of Economic Analysis. Retrieved August 12, 2015 from http://www.bea.gov/national/xls/gdpchg.xls

Federal Reserve 2008 Annual Report. Retrieved August… READ MORE

How to Reference "Fed's Response to 2008-09 Recession" Research Paper in a Bibliography

Related Research Papers:

U.S. Macro-Economy: The United States Research Paper

U.S. Macro-Economy:

The United States economy is expected to grow by approximately 2% in the coming year, which is roughly the same level of growth it has experienced this year.… read more

Research Paper 5 pages (1600 words) Sources: 3 Topic: Economics / Finance / Banking

---

Monetary Policy Tough Love: Should the Fed Essay

Monetary Policy

Tough Love: Should the Fed Stop Worrying and Learn to Love Inflation?

Given the depth of the recent economic contraction and the credit market dislocations that accompanied it,… read more

Essay 7 pages (2966 words) Sources: 8 Topic: Economics / Finance / Banking

---

External Analysis for Many Companies Thesis

External Analysis

For many companies, the external environment is the most important driver of the business. A variety of factors come into play -- the state of the economy, the… read more

Thesis 9 pages (2957 words) Sources: 1+ Topic: Business / Corporations / E-commerce

---

Troubled Asset Relief Program Tarp Effectiveness Thesis

financial crisis and its impacts on the U.S. economy. The TARP program was created to deal with these impacts, and this paper will analyze TARP in terms of its success… read more

Thesis 10 pages (3393 words) Sources: 9 Style: APA Topic: Economics / Finance / Banking

---

Is Quantitative Easing a Suitable Policy? Research Paper

Both controllable and uncontrollable factors thus suggest that the projected negative impacts of quantitative easing are unlikely to be as severe as naysayers feared, even though the recovery sustained was… read more

Research Paper 7 pages (2223 words) Sources: 7 Topic: Economics / Finance / Banking

---

View 100+ more related papers  >>