Week 22 - Stabilising the economy Pt3 Flashcards
(31 cards)
Why did the Fed turn to Large-Scale Asset Purchases (LSAPs)?
The federal funds rate was near zero, limiting conventional monetary policy options, while the economy remained weak and deflation was a concern.
What assets did the Fed purchase under Large-Scale Asset Purchases (LSAPs)?
Treasury securities and mortgage-related securities from government-sponsored enterprises (GSEs).
When were major LSAP programs announced?
March 2009 and November 2010.
By how much did LSAPs expand the Fed’s balance sheet?
By more than $2 trillion.
How did LSAPs affect Treasury yields and long-term interest rates?
Reduced the available supply of Treasuries, which led investors to accept lower yields, decreasing long-term interest rates.
How did lower long-term rates help the economy?
They stimulated economic activity, similar to the effect of conventional monetary policy.
How were Large-Scale Asset Purchases (LSAPs) financed?
By increasing bank reserves at the Fed, not by increasing the money in circulation.
Did LSAPs significantly increase the money supply in circulation?
No, they primarily added to bank reserves rather than circulating money.
What are some ways the Fed can unwind LSAPs?
By selling the acquired securities back into the market.
What was the primary financial effect of LSAPs on interest rates?
They lowered longer-term interest rates.
How did LSAPs contribute to economic recovery?
By reducing long-term interest rates, they helped stimulate economic activity.
Which sector did LSAPs have a weaker-than-expected effect on?
The housing sector.
Are LSAPs considered government spending? Why or why not?
No, because the Fed plans to sell the assets back into the market eventually.
How does clear communication from the central bank improve monetary policy?
It helps investors understand policy goals and better anticipate future actions.
What is forward guidance in monetary policy?
It is the Fed’s communication about how it expects to adjust the federal funds rate in the future, based on current economic conditions.
What is the purpose of forward guidance?
To help the public and investors understand the Fed’s views and future policy intentions.
Government Responses:
Monetary and Fiscal Policy during Covid-19
Fiscal Policy 3/18: Passage of the Families First Coronavirus Response Act Monetary
Policy 3/19: Fed announces liquidity arrangements with
smaller banks
Monetary Policy 3/23: Fed announces unlimited purchases of MBS; commercial paper; AAA securities
Fiscal Policy 3/27: Passage of Coronavirus Aid, Relief, and Economic Security (CARES) Act
Monetary Policy 4/6: Fed lowers community bank leverage ratio from 8% to 9%
Fiscal Policy 4/24: Passage Amendment to (CARES) Act
2020 Monetary Policy Actions
- Federal Funds Rate
– Reduced 0.25% (to a 1.25% to 1.50% range) on March 3, 2020
– Reduced to 0.00% to 0.25% range on March 15, 2020 - Eliminated the reserve requirement
- Cut discount rate to 0.25%
- Pledged to work with other central banks
- Reduced the leverage ratio (portion of Tier 1 assets) from 9% to 8% instead of compelling mark-to-market
- Engaged in quantitative easing of $3 trillion
- The effectiveness of monetary policy depends on whether the monetary transmission mechanism works.
- If not, that is called the liquidity trap.
Fiscal Policy
- Coronavirus Preparedness and Response Supplemental
Appropriation: $8.3 billion
– Enhanced funding for testing, NIH, CDC, etc.
– Funding for COVID-19 tests - Families First Coronavirus Response Act: $192 billion
– Paid leave for those who were sick, quarantined, caring for someone sick/quarantined, those with children out of school - Coronavirus Aid, Relief, and Economic Security (CARES) Act: $2.5 trillion (two steps)
– Paycheck Protection Program - Loans/grants to business
– Pandemic Unemployment Assistance - Unemployment insurance payments for the self-employed
– $600 unemployment compensation supplement
– Stimulus checks
The Effects of Crises on Central Bank Practice
- In the decades before the financial crisis, central banks often viewed financial stability policy as the junior partner to monetary policy.
- The crisis underscored that maintaining financial stability is an equally critical responsibility.
- Financial crises will always be with us. But as much as possible, central banks, governments and other regulators should try to
anticipate and defuse threats to financial stability and mitigate the effects when a crisis occurs. - The Great Recession served as a primary lesson for Central Banks in how to respond to the Covid-19 economic fallout.
- The unconventional tools used in both the Great Recession and Covid-19 helped to prevent the repeat of the 1930s Great Depression.
- These should set the stage for a slow but continuing economic recovery.
What factors make macroeconomic policy work best?
Accurate knowledge of current economic conditions
Forecast of the economy’s future path without policy
Precise value of potential output
Good control of fiscal and monetary tools
Understanding of how and when the economy responds to policy changes
What do the Great Recession and COVID-19 economic crisis illustrate about the economy?
That financial and health crises can cause major damage to economic activity.
Why is macroeconomic stabilisation policy important during crises?
To limit the size and scope of economic meltdowns.
How does the real interest rate r affect consumption C?
It reduces consumption:
𝐶 = 𝐶ˉ + 𝑐(𝑌–𝑇) – 𝑎𝑟
