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Federal Reserve Policy during the Recession and Effects of the Credit Crunch - Assignment Example

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Federal Reserve Policy during the Recession and Effects of the Credit Crunch

This was in September 29, 2008 and was in reaction to the US recession. The Fed Reserve, realizing there was a shortage of American currency, in the EU, decided that it would improve swap facilities to $620 billion from $290 billion with central banks from overseas. It also announced that it would buy mortgage and debt, which was worth $800 billion. This would be a separate fund from Troubled Asset Relief Program, which was also formed to combat the effects of the recession and was worth up to $700 billion. By December 2008, the Fed Reserve had independently spent over $1.2 trillion in the purchase of specific financial assets. A significant amount of the funds used by the Fed Reserve was meant to rescue firms deemed ‘too big to fail”. The Fed Reserve used, up to $100 billion, to buy debt from Freddie Mac and Fannie Mae, as well as up to $500 billion to buy mortgage-backed securities from these firms. This intervention by the Federal Reserve went some way in buffeting the banking sector from the economic and financial recession, especially with the over $200 billion given to security holders with the backing of consumer loans like student loans and credit cards. This kind of intervention normally works to unfreeze consumer debt markets (Amacher & Pate, 2012). Part Two: The Effect of Bank Lending on the Economy With the availability of competitively priced loans and cheap loans dwindling, more consumers have become increasingly concerned with regards to their finances (Amacher & Pate, 2012).

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Because of the issues that have befallen the wider economic and financial market, slightly more than 20% of American consumers are more concerned about borrowing via credit cards and personal loans. For this reason, consumers tend to take steps to reduce their spending as low cost consolidation loans becoming a way of doing this. In addition, increasingly more consumers tend to reduce expenditure because of concerns about increased repayments on loans, spending less money and saving more of their money. The credit crunch also affects business investments since businesses are forced to decrease or even stop investments as they cut down on borrowing. As banks tighten their credit, loans become too expensive and businesses cut back on borrowing (Amacher & Pate, 2012). Since businesses rely on the banking system being healthy, the bailout occasioned by the financial crisis has resulted in a credit crunch, which has seen banks putting money in US Treasury Bills, rather than loaning it to businesses and consumers. Ultimately, the above strangles business investment. The credit crunch also leads to reduction of wealth as consumers and businesses cannot borrow to create wealth, which has a knock on the effect on aggregate demand, shifting it leftward (Amacher & Pate, 2012). The credit crunch eventually leads to decreases in financial and other stocks, leading to decreased expenditures, which shifts to the left the demand curve. The GDP also underperforms when there is a credit crunch since resources are not used effectively due to decreased borrowing, which ultimately hurts business confidence and decreases investment. Finally, the credit crunch also increases unemployment since businesses cannot borrow to pay staff wages and suppliers, which leads to staff lay-offs. In addition, the still employed staff cuts down on their spending, as a result, it affects, the demand for products and services from other companies, which are also forced to lay off staff. This causes a downward spiral that leads to people losing employment (Amacher & Pate,

Summary

FEDERAL RESERVE POLICY DURING THE RECESSION AND EFFECTS OF THE CREDIT CRUNCH
Part One: Federal Reserve Bank Policy during the 2007-2008 Recession
Federal Reserve Policy during the Recession and Effects of the Credit Crunch
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