Economics - Essay Example

Download file to see previous pages... Although, Federal Reserve uses monetary policies tools such as open market operations, the discount rate and reserve requirement, the tools affect the economy either positively or negatively (Giuseppe, 2009). More so, increase or decrease of the reserve requirement affects interest rates in a short period as financial institutions lack funds to issue to investors. Nonetheless, higher discount rates make borrowing less attractive from Federal Reserve for many banks while low discount rate make borrowing more attractive for banks because they have access to more deposits. More so, it is necessary to establish how monetary policy caused the financial crisis in the country Considerably, Federal Reserve plays a crucial role in determining money supply in the economy that eventually affect credit availability and the interest rates in the United States. More significantly, Federal Reserve lowered interest rates in 2001 as it induced investors to borrow money to finance mortgages and purchase of houses for speculation. However, in 2004 Federal Reserve increased the interest rates making payments of mortgages difficult thus, leading to increase in house prices. More so, businesses and individuals had accumulated a lot of interest from the mortgages, making it difficult to pay leading to high defaulting rate of the borrowed funds. More than that, the boom in house markets impacted on financial market lead to high levels of delinquencies and foreclosures. Considerably, the recession period was marked by high levels of economic downturn as the decline in the gross domestic product increased with high levels of unemployment during the recession period (Giuseppe, 2009). In addition, there is a lower level of money in the economy with a high level of bankruptcies and default in loan repayment crisis as real income declines with the economic downturn becomes worse impeding the Federal Reserve to take action as the economic recession period showed likelihood of economic depression era occurrence. In addition, the Federal reserve set reserve requirements limits for banks and financial institutions as it decreased reserve requirements between 2001-2005 by about 20% funds reserves owned by banks were used to give out more loans to businesses and individuals. As a result, there was an increase in money supply available in the economy thus, leading to inflation. However, in 2005 to 2008 Federal Reserve revised its monetary policy reducing the growth of GDP as it enhanced reduction of money supply in the economy. Nonetheless, the development of collateral mortgage obligations structured product served as a security for borrowing of money thus, individuals later had easer availability to loans .as they used insurance as security for the provision of safety for the loan borrowed if defaulted (Blanchard, 2008). Nonetheless, Federal Reserve failed to recognize liquidity problem in 2007, as it increased the interbank rates while failing to provide an immediate solution to the increasing money supply. As a result, interest rate rose to unprecedented levels that eventually led the economy into a period of recession. With the worsening of the economy, the Federal Reserve provided solutions meant to solve challenges that the USA economy was facing in the year 2008 as it uses monetary policies to solve the financial crisis. Federal Reserve increased money supply in t ...Download file to see next pagesRead More