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Running Head: MONETARY POLICY
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Monetary Policy
Name
Institution Affiliation
MONETARY POLICY
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Abstract
Monetary policy refers to the drafting and implementation of a set of strategies by
relevant authorities such as the central bank, which function to impact the critical drivers of a
country’s economy. In 2008, an economic crisis with its roots on the housing sector of the United
States spread to the financial areas of the country and then globally, with reports having it as the
worst recession since the great depression of the 1930s. However, the United States Federal
Reserve initiated a series of actions that aimed at dealing with macroeconomic problems such as
unemployment and pricing in the nation and bring the economy back to its feet once again. The
Federal Open Markets Committee together with entire Federal Reserve administration launched
several responses; a reduction on interest rates, assistance to financially troubled institutions,
Qualitative easing and communication tools such as the forward guidance. All these policies,
explored in this paper, contributed both individually and cumulatively to the emergence of the
United States out of the great recession.
MONETARY POLICY
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Monetary Policy
Background Information
The central bank is mostly the authority tasked with the responsibility of making
decisions concerned with monetary policy in a country. The Federal Reserve has this mandate in
the United States. It consists of twelve regional banks headed by a chairperson, and a board of
governors who go through tons of research to ensure that America responds adequately to
matters of economic stability and growth. From mid-2007, the United States began to report a lot
of reduced unemployment and instability of prices characterizing a serious, developing issue.
The Federal Reserve Open Market Committee functions as the arm of the Federal Reserve
responsible for determining how the central institutions will react in the best interest of the
economy. The ax of the financial predicament fell when housing prices declined, crippling
slowly but steadily the banking system internationally.
Pre-Crisis Policies
It became a hotly debated argument on what exactly caused the financial crisis in the
United States. Some said that the blame fell hard on the expansionary policies that set the stage
for low borrowing costs that ultimately caused institutions to hold on to risky assets (Moretti,
2019). However, the chairman of the Fed contested this thinking by proposing that other factors
unrelated to monetary policy led to the slump in the American, the and international economy in
general.
The central bank makes sure to maintain its targeted federal fund’s rate by giving explicit
guidelines to the New York reserve administration to keep reserves in the banking system at
agreed-upon levels. The Desk initiates Repo and Reverse repo transactions which significantly
MONETARY POLICY
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help in the adjusting of the supply of money in the reserves. Repo functions with the concept of
buying treasuries, securities with mortgages under a contract that allows it to sell the purchased
items prospectively and at a sufficient amount. On the other hand, Repo Reverse happens when
the Desk trades securities and treasuries under the arrangement that it will repurchase those
items, in the future, for a value higher than the selling price. These two actions served to
decrease and increase, respectively, the overall reserve balances in all the banks. Also, the desk
ran checks daily to ensure that all its operations were in line with all the factors that affected the
reserve. The overnight Reverse Repo specifically worked to furnish the Fed’s primary tool in the
quest to regulate the rates on short-term interests (Federal Reserve Bank of New York, 2019).
Policies During and after the crisis
Interest rates
During the onset of the economic decline in August 2007, the Federal Reserve employed
its primary tool, interest rates, to ensure that institutions could conduct business at lower costs.
The institution decreased the federal funds rate, to a lower one, allowing banks to trade and
engage in payments overnight. This move functioned to increase the money supply in the
economy and to deal with rapidly rising unemployment in the country. Since the economy was
on a state of depression, the concept was practical, since the decline provided room for the
creation of more jobs and the increase in economic output.
However, to public dismay, the conventional tools were not working, and the Fed
continued to decrease the rates until they were almost at zero, and still, there remained minimal
improvement. From late 2007 to June of 2008, it dropped the interest rates until it dawned on the
whole administration that it was no longer possible to stimulate the economy with traditional
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techniques in monetary policy. It was crucial that the Federal Reserve pay mind to the Zero
Lower Bound that would limit its capabilities in handling the problem with conventional means.
Therefore, in this situation, the central bank had to think creatively in a bid to save the economy
by initiating a mechanism of stimulating it. It was undisputed that it was useless and a waste of
time to support any action that forced out a negative rates equation as it would only lead to an
endless sequence of withdrawals from all banks, dropping all payment processors and leaving the
crisis at an almost worse state. For this reason, it was up to the Federal Reserve to come up with
innovative strategies to put a cap on the slump and, stimulate the economy through whatever
means possible.
Company bailouts
Before initiating the string of alternative tools to stimulate the economy once again, the
Federal Reserve made one painful discovery; core institutions were on the verge of crumbling
down, and without help, their collapse would create the much-dreaded domino effect that would
sink the international banking system. The failure of the Lehman Brothers displayed the harsh
and costly consequences of the failure of an establishment of such stature (Yglesias, 2015). The
investment bank came crumbling because it received no offers from interested parties willing to
buy it out of its miseries, also because it was not eligible for loans.
This painful lesson brought the board of governors and the Congress to the same page,
and together they launched the relief program that offered aid to financial aid to troubled
institutions like AIG, the Bear Stearns, and even the Morgan Stanley. The Federal Reserve
provided secured loans to these institutions and also allowed them access to overnight lending on
flexible terms. This policy worked under the concept of offering affordable financial aid to more
banks to deter any more bankruptcies that would worsen the crisis.
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Qualitative Easing
This monetary policy, unlike the other conventional ones, targeted economic stimulation
especially when rates operated at, or close to zero. Here, the Fed was to make a considerable
number of purchases on securities in a bid to increase the supply of money and inspire people to
invest and to borrow from lenders. The administration calculated its desired outcome and then
ensured to achieve that dollar quantity by purchasing as many assets as possible. This move
would serve to increase the amount of money in the economy, which was an easy way of
reducing its overall value and make it easier for banks to lend money at low rates.
However, the administration risked many shortcomings, since, first, the Quantitative
Easing mechanism (QE) could result in inflation on a national scale. Still, this situation did not
mature since most banks kept the money in their reserves, reducing the amount of cash available
in the population, causing an unexpected result. Secondly, the untraditional instrument would
also result in a complete devaluing of America’s inland currency which would be a devastating
consequence to importers thereby affecting economies of scale significantly.
After the implementation of the first phase, QE boasted a national increase of over $4
trillion; all injected into the economy. Here the balance sheet tipped on both sides, with the hope
that this money would go a long way in revitalizing the economy and ease the financially
troubles characteristic of the times (Bernanke, 2012). Unfortunately, most institutions did not
lend out the money and instead, kept more of it packed away. Until 2008, it was not legal for
banks to receive interest on their excess balances and this change might have to be responsible
for the unexpected outcome of over $2.7 trillion stashed away by banks in excess reserves
(Chappelow, (2019).
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However, understanding the reason for the administration legalizing interests on reserve
remains crucial. On the upside, this institution wanted to prevent prospective inflation by
providing incentives to those banks that held on to much of their money. It remains conflicting
because the goal of QE was to ensure that people trusted investing and spending more than
keeping their money hidden away. It would have been more effective, theoretically, if the people
felt that the Federal Reserve was unable to contain inflation shortly, forcing them to use most of
their money, thereby increasing economic activity.
Forward Guidance
Forward guidance is the most well-known communication tool used as a driver of
economic growth. As this progress remained exceptionally slow, it was up to the Fed to
communicated with the people about the future of markets to inspire their decision in the present.
The concept worked under the impression that people reacted currently courtesy of their belief of
what was more probable in the years to come.
The Federal Reserve, however, ran into conflict during the attempt to implement this
policy based on the concept mentioned above. The theory presented a dilemma that would leave
people stranded, thereby reducing the progress on increasing employment and stabilizing prices
(Yglesias, 2015). The statement on unrelenting low rates would pass as either a message urging
people to buy more houses, cars, and other assets or, that chances were small that the economy
would pick at any time in the future, pressing individuals to give up on any economic activity
whatsoever.
To this effect, they turned to a concept earlier proposed by Charles Evans, one of the
presidents of the twelve regional banks, which suggested a new level of assurance to people
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concerning interest rates. The Evans Rule ensured that the Fed maintained the interest rates so
long as inflation was at the 2-2.5% bracket (Yglesias, 2015).
The Effectiveness of the Policies
The purpose of the initial responses by The Federal Reserve was to stimulate the
economy by reducing interest rates thereby allowing banks to trade with each other and
increasing their lending capacity. However, this policy had minimal impact, forcing the Fed to
drop more basic points until finally they were at zero and conventional methods could no longer
be productive.
The next category of policies functioned to support aiding markets and institutions and
help them through their financial struggles. After the fall of the Lehman Brothers, it became
imperative that Congress hold hands with the Federal Reserve to prevent more core banks and
financial institutions from crumbling down. The strategies herein went a long way in preventing
a domino effect that was inevitable if investment banks like the AIG collapsed, which would
significantly affect the international system of finance.
The Federal Reserve lastly initiated alternative policies that purposed to spur economic
growth and increase employment opportunities by inspiring investments and the level of
spending. This concept began with the calculation of the desired asset worth that it wanted to buy
and then started making the purchases. The Fed bought bonds and other items in large scale
thereby introducing tons of cash into the economy. By 2008, the program resulted in an
increased supply of $4 trillion into the United States economy (Chappelow, (2019). The
initiative’s overall effectiveness, however, remains debatable since most of the money did end up
as reserved excesses and not in people’s pockets stimulating economic activity. It was, also,
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fortunate that this unexpected outcome did not cause the loss of currency value, and that there
was no inflation, generally. Nevertheless, although, the desired results were unachievable for
reasons more than one, the concepts of Qualitative Easing contributed immensely in the rescuing
of the international financial market, begin with the United States out of the economic decline .
Finally, the Federal Reserve introduced the Evans Rule as a communication tool which assured
people that interest rates would remain at the ten current figure for a specified period regardless
of inflation, thereby pushing people into engaging in economic activity.
Conclusion
From late 2007 to June 2009, the recession terrorized financial institutions globally,
eating away employment opportunities and causing the worst possible instability on prices.
However, the Federal Reserve of the United States, through its arm FOMC, tasked with the
mandate of influencing monetary policy, launched a series of actions that aimed to revitalize
positive economic activity once again and reverse the increase in unemployment rates and
stabilize prices.
The crisis began with the drop in prices in the housing sector and rapidly spread to the
financial area and finally took a toll on the international banking system affecting the prices of
oil and other trend-setting products. The Federal Reserve responded with various policies that
attracted different results, both intended and unexpected. It began by initiating an interest cut
which aimed at increasing liquidity in the population by improving the willingness of the banks
to lend money to people, especially in the short term.
However, this regulation failed to work, and the central bank ended up decreasing the
federal funds rate until they could lower it no more. Still, there was very little progress regarding
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employment and prices, and so the Fed had to think of more creative ways to beat the Zero lower
Bound that limited the policies it could implement to stimulate the economy once again. To this
effect, it initiated a series of unconventional methods starting with the bailing out weak markets
and core institutions which, unless attended to, would cause an undesirable meltdown.
The Fed then began vas purchasing program aiming to pump as much money into the
economy as possible. These funds were to allow banks to lend money to people so that they
could venture into business deals that would create job opportunities which would have an
immense impact on stabilizing the main products. Although the expectations were not as
expected, these policies did help in ending the slump that got nicknamed as the worst recession
after the Great Depression of the 1930s.
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References
Bernanke, B. (2019). Speech by Chairman Bernanke on monetary policy since the onset of the
crisis. Retrieved from
https://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm
Chappelow, J. (2019). Quantitative Easing Definition. Retrieved from
https://www.investopedia.com/terms/q/quantitative-easing.asp
Federal Reserve Bank of New York. (2019). Monetary Policy Implementation – FEDERAL
RESERVE BANK of NEW YORK. Retrieved from
https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policyimplementation
Moretti, L. (2019). Monetary policy before the crisis | VOX, CEPR Policy Portal. Retrieved from
https://voxeu.org/article/monetary-policy-crisis
Yglesias, M. (2015). The Fed and the 2008 financial crisis. Retrieved from
https://www.vox.com/2014/6/20/18079946/fed-vs-crisis

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