Federal Reserve Monetary Policy on the US - Article Example

of the Number: Paper: Table of Contents Introduction 3 Summary: Article 4 Summary: Article 2 5 Summary: Article 3 6 Conclusion 7 References 8 Introduction Central Bank Policies that are directed to promote growth always contain some risk elements. The global financial crisis was a major setback that forced policymakers to continuously monitor and regulate monetary policies. After the financial crisis, the Federal Reserve concentrated on regulating asset prices by balancing it with monetary policies. There were situations when the Federal Reserve acted parsimoniously and were skeptical about rate cuts. They were fearful of the fact that rate cuts often inflate asset prices and debts associated with household activities. Controlling price is a major concern in the United States (U.S.) economy (Gilchrist & Leahy, 2002). Fall in inflation is also a cause of concern. At some circumstances, rise in inflation above a certain level is good for regulating growth. Interest rates are kept at zero for a long period of time and inflation is allowed to rise above a certain level. The valuation of the U.S. household is reasonable and there is a falling trend in household debt. The small banks take advantage of the prevailing low interest rates by increasing their bondholding share. When rates are raised suddenly, the banks are exposed to massive losses (Rigobon & Sack, 2004). The policymakers in the Federal Reserve are more concerned about an abandoned recovery than unstable financial conditions. The Federal Reserve tried to simulate two reactions that were noticed after financial crisis. One response suggests that rates fall down to zero and it triggers the chances of another crisis after ten years which would be equally bad as the previous crisis (Rigobon & Sack, 2004). The other response propose that rates do not fall lower than 1.5% and this would ensure that a crisis in the future is avoided (Iacoviello, 2005). In this study, further discussion on the above issues are put light on and the effects of Federal Reserve Monetary Policy on U.S. Asset Prices are summarized with the help of three articles. Summary: Article 1 The article stresses on identifying ways in which the central bank tackles volatility in asset prices and regulates the overall monetary policy. It is certain that monetary policy alone cannot explain the movements in asset prices. However, it is an important factor that has to be critically analyzed. The article principally proposes that in the short term, Central Bank’s monetary policy should consider stability in prices and financial conditions as complementary to each other. This would require mutually dependable objectives and an integrated policy framework. The primary step would be to achieve a flexible rate of inflation. A target of flexible inflation can help to regulate monetary policies in all kinds of economic conditions. Interest rates are adjusted automatically by the policymakers in a stable direction when there are disturbances in asset price. Aggregate demand increases with the increase in asset price and it falls with fall in asset price. In this process of stabilization of asset price, interest rate also gets adjusted. So, interest rate moves in alignment with asset prices. Inflation targeting furthermore suggests that stock price movements can be ignored as they do not explain the inflationary pressures (Bernanke & Gertler, 2000). Asset prices become a concern for the policy makers when volatility in the asset market is influenced by non-fundamental factors. Another cause of concern arises, when the real economy gets affected by the recessions and booms in the markets for asset. The above discussion can be explained by a model designed by Bernanke, Gertler and Gilchrist which is known as the BCG model (Bernanke & Gertler, 2000). The model is based on the foundation of the Neo Keynesian Model. This model would help in the understanding of bubbles in prices of assets. The household and the financial sectors are considered in the model. The interest rate in the short term can be controlled due to flexible nature of this framework. The balance sheet of the borrowers is impacted by the interest rate. Ease in policy by reducing real rate of interest leads to an increase in asset prices which in turn increases the financial condition of borrowers. In the whole process, the premium on external finance falls. The model concludes that financial accelerator binds the economy and volatility in asset price. This model is later extended for studying other alternative shocks (Bernanke & Gertler, 2000). Summary: Article 2 The article aims to critically analyze the relationship between the Central Bank’s monetary policy and the price of assets. The asset prices are governed by various conventional principles. Asset prices should not be targeted by the Central Bank. The Central Bank’s activities should also not instigate a bubble in asset prices. A strategy should be designed that would help to insert significant liquidity to avoid a financial recession. This strategy would be followed if a price bubble occurs. There is absence of appropriate tools and mechanism with the Central bank that would help to cater to targeted asset prices. The Central Bank’s image will also jeopardize if it instigates a macroeconomic catastrophe by asset price bubbles. However, when a bubble takes place, it is the responsibility of the Central Bank to handle and manage such circumstances wherein the asset prices collapse (Issing, 2009). The article later on discusses the role of monetary and credit expansion. Unsteady development in valuation of asset can be limited or restricted by strategizing monetary policies effectively. Monetary policy can be effective if it evaluates and regulates developments in credit and monetary issues. Such strategic monetary policies can also influence price inflation in the long run (Issing, 2009). If the monetary and credit policies remains stabilized, the asset prices will also be sustainable over time. Changes in price of asset thus can be explained by the analysis of the nature of growth in credit and money. The article also throws light on the empirical works done in the literature which suggest that there has always been some bubble in asset prices (Detken & Smets, 2004). Asset cam be priced properly if analysis of the monetary condition is done appropriate and this is reflected through the monetary policy. Risk is minimized or managed in an integrated manner if a wider time period is considered for making monetary policies. This process works in a symmetric fashion explaining decline in asset price as well as increase in asset price. This is a different approach where the policies do not come into play only when the economy is financially weak (Issing, 2009). The symmetrical nature of the approach can be maintained if credit and money are regularly monitored and then rechecking the outcomes with the monetary policies. The application of the model becomes feasible and permanent if the functions are operated appropriately. The policy is understood and assessed effectively. The article thus, concludes that monetary changes thus need careful evaluation that would strengthen economic movements and specifically asset price movements in the household markets (Issing, 2009). Summary: Article 3 The article takes the help of the market for acquisitions and mergers to explain the relationship between monetary policy by Federal Reserve and asset prices. The Federal Reserve aims at maintaining a certain rate of interest by adjusting the supply of money. For that purpose, the optimal level of rate of interest has to be identified. There are many studies which help to determine the optimal rate. However, the literature does not focus on the transactions related to mergers and acquisitions. The theory of monetary policy advocates that, asset prices are increased when interest rates fall due to pessimistic shocks to monetary policies. Borrowing cost is reduced when there is a reduction in rate of interest. The firms are affected when levels of investment reduces due to the lower interest rate. This in turn, reduces the price of asset. Vector Autoregressive (VAR) analysis is used to empirically support the objective of the article. However, no significant causal relationship is found between activities concerning merger and acquisitions and monetary policy (Ubl, n.d.) The alternative outcome of the analysis in the article suggests that, movement in mergers and acquisition can be significantly explained by the Gross Domestic Product (GDP). This reflects the fact that, asset prices movements of the transactions related to mergers and acquisitions are mainly influenced by the output of the economy. The results of the empirical study adds to the literature of monetary policy and significantly contributes by proposing that ,activities related to mergers and acquisitions can now reflect asset prices and thus, can be added to the class of asset. However, the empirical analysis fails to establish a relation between monetary policy and asset prices that governs the transaction of mergers and acquisitions. The above relation can hold implicitly and this can be explained indirectly by the results of the analysis. This can be explained by the fact that output is massively affected by monetary policies which in turn affects the market for mergers and acquisitions. The direct relation between monetary policy and merger & acquisition movements is not established by the empirical study and as a result, the channel of asset price does not hold. The article thus helps to understand the relation between monetary policy and prices of asset in the market for mergers and acquisitions (Ubl, n.d.). Conclusion All the three articles try to evaluate the effects of Federal Reserve Monetary Policy on U.S. asset prices. This can be done by studying the relationship between monetary policy and the asset prices. An attempt has been made in the articles to see how monetary policy and the bubble in housing prices are related. There are debates over the same. Some policymakers argue that monetary policy has no role to play in asset price movements. Others find significance between the both. The actions of the policymakers that concerned with monetary policy regulations after the financial crisis helped in overcoming the downturns and the U.S. economy is still in the recovery phase (Goodhart & Hofmann, 2001). Problems leading to a financial collapse are identified and efforts have been taken to design steps to avoid such situations in the future. Monetary policy was considered to be playing a vital role that led to the crisis (Filardo, 2000). The easing of monetary policies led to a bubble in prices of housing which eventually led to the massive financial crisis. There are debates over the same. So, it becomes imperative to understand how monetary policies effect prices of assets. All the three articles follow different approach to explain the effects. From the overall synthesis of the articles it can be concluded that, monetary policies have an influence on asset prices either directly or indirectly (Bordo & Jeanne, 2002). References Bernanke, B. & Gertler, M. (2000). Monetary policy and asset price volatility. Retrieved from http://www.nyu.edu/econ/user/gertlerm/kansasfed.pdf Bordo, M. D. & Jeanne, O. (2002). Monetary policy and asset prices: does ‘benign neglect’ make sense? International Finance, 5(2), 139-164. Detken, C. & Smets, F. (2004). Asset price booms and monetary policy. Macroeconomic Policies in the World Economy, Springer, Berlin, 189-227. Filardo, A. J. (2000). Monetary policy and asset prices. Economic Review-Federal Reserve Bank of Kansas City, 85(3), 11-38. Gilchrist, S. & Leahy, J. V. (2002). Monetary policy and asset prices. Journal of monetary Economics, 49(1), 75-97. Goodhart, C. & Hofmann, B. (2001). Asset prices, financial conditions, and the transmission of monetary policy. Conference on Asset Prices, Exchange Rates, and Monetary Policy, Stanford University, 2-3. Iacoviello, M. (2005). House prices, borrowing constraints, and monetary policy in the business cycle. American economic review, 739-764. Issing, O. (2009). Asset Prices and Monetary Policy. Cato J., 29, 45-51. Rigobon, R. & Sack, B. (2004). The impact of monetary policy on asset prices. Journal of Monetary Economics, 51(8), 1553-1575. Ubl, B. R. (no date). The Relationship between Monetary Policy and Asset Prices. The Developing Economist, 50-84. Read More