Monetary Policy Fed Monetary Policy Research Proposal

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When interest rates are low, people have a greater incentive to borrow and to spend money. That new car or home they have been 'putting off,' seems much more attractive when the interest rate is nearly zero! But perhaps "the most effective tool the Fed has, and the one it uses most often, is the buying and selling of government securities in its open market operations. Government securities include treasury bonds, notes, and bills. The Fed buys securities when it wants to increase the flow of money and credit, and sells securities when it wants to reduce the flow" (Obringer 2009, p.10).

Given the magnitude of the current economic crisis, the Fed has been taking aggressive actions with the specific aim of stimulating consumer spending, and hopefully production and employment to meet increased demand as a result: "The target fed funds rate will be below .25%…effectively at zero. The Fed is going to the 'zero bound' (i.e., a nominal rate of 0%, below which a lender has to pay a borrower to take the money, which is unlikely to continue for long). Monetary policy has been effectively at zero for some time. It will be 0-.25% until probably 2010" (Tepper 2008). In a less publicized, but still critical action, the Fed has been purchasing private securities to inject funds into the economy" (Tepper 2008). Because the Fed "expects a long and deep recession" it therefore plans on long-term policy commitment to low rates" for both consumers and banks (Tepper 2008).

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Because unemployment is escalating, people now fear spending and fear losing their jobs. The Fed hopes that low interest rates will encourage people to spend, encourage economic stimulation, and as more people find work and make money, the economic stimulus created through this monetary policy will continue. Inflation is far less of a concern than chronic unemployment at this time, although during periods of American history such as the 1970s, high unemployment and high inflation have co-existed. However, this current economic crisis has brought some new complications. The credit 'crunch' or high rate of loan defaults has made many banks, even if they have large amounts of money in reserve, very wary of lending money to all but the best borrowers. Newly chastised consumers, even if they are solvent, are scaling back their lifestyles. Even regarding securities: the usual bank traders are not buying Treasury notes "because they don't have enough spare resources" on hand to do so (Tepper 2008). The difficulty of remedying the current situation with monetary policy alone highlights the need for federal action and spending to stimulate the economy. Sometimes monetary policy alone is simply not enough of a recourse, however aggressive the actions of the central bank.

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