Economics of Global Money Markets - Essay Example

Federal Reserve The paper talks about a review of United s monetary policy evolution since 2008. The focus will be on the experience of Federal Reserve with traditional policy tools. The discussion will be on drawbacks and efficiency of the less familiar monetary policy forms. Furthermore, the paper will talk of the implications of the ongoing measures to boost price stability and maximum employment. Monetary policy 2008 When substantial financial crisis emerged five years ago, there was a quick response by the finance committee that was in place, by use of liquidity approaches that lowered the discount rates and extended term loans and in the following month by decreasing the set targets for the rates of federal reserve by 50 points. As economic indications weaknesses advanced over successive months, the rates of federal funds target was lowered by 325 points by the committee, leaving it at 2% by the end of 2008 (Oulette, 2014). During the summer, the rates were held constant by the committee as it watched financial and economic conditions. As the crisis grew worse at the fall of summer, finance committee responded through lowering rates of federal funds target by 100 points, with this coming unparalleled cut of interest rate by central banks. In December, evidenced by dramatic slowdown, the committee lowered its target at a range of 0-25 points. Up to date the range as remained with no interference. In spite of monetary policy easing, under performance in credit markets worsened off. Towards the end of 2008 and at the start of 2009, the Fed took astonishing measures to give support and liquidity to functioning of credit markets inclusive of establishment of various emergencies loaning facilities and extension or creation of currency exchange agreements with fourteen central banks globally. As a regulator of all banks, the Fed led the largest America bank holding firms’ stress test, creating stage for firms to increase their capital (working mother, pp.66).The actions with interventions from policy makers in America and globally assisted to stabilize financial world markets, which later checked on the weakening of real economy with deflationary pressure emergence.Though it is probable that worse results had been stopped, the destruction to the economy was already severe. The rate of unemployment in the U.S rose from 6% in 2008 to 9% by 2009 as inflation decreased sharply. With the increase of the crisis, and rate of federal funds on the lower bound, the committee resorted to non-traditional boundaries approaches to counter the crisis. When the committee returned on its path, there were guidelines some academic work and general principles but with a vital exception of Japanese case historical experience. Consequently, United States central bankers and the ones in developed countries facing same problems have learnt by acting. The economy therefore, has learnt to use balance sheet of Federal Reserve and communication tool. Economic Prospects The monetary policies that have been reviewed in this paper, both nontraditional and traditional gave vital support to the recovery of U.S economy while assisting to keep the price stability. By July, the rate of unemployment had dropped to 8.3% from its recurring top of 10% and payrolls rose by four million jobs. And in spite of periodic worries about deflationary risk and besides, warned over and over again that more policy accommodation will trigger inflation and in turn inflation has been near 2% of the committees objective and expectation of inflation have maintained stability. The key sectors of the economy such as international trade, housing, company investment in assets, manufacturing and conditions in credit and financial markets have been made better. Nonetheless without standing these good signs, the situation of the economy is not near satisfaction. The rate of unemployment remains at more than 2% points beyond what most committee participants view as its long term normal value, with other signs like participation rate of labor force and count of individuals not working full time for economic purposes- confirms that the use of labor force remains at low levels. Moreover, the improvement rate in the market of labor has been slow. It has been noted that on other events that unemployment decline as viewed would probably continue if only economic growth rose above its long term trend rate. (28). In fact, recent quarters growth has been warm, and therefore, not astonishingly, there have not been any net boost in the rate of unemployment since January. If the economy does not grow more hastily than it has of recent, unemployment rate stands to remain above levels steadywith optimum employment for a period of time. In line with the policy implementation the committee has done to date, there might have been hope for more progress by this time in going back to optimal employment. Other individuals have used no progress to be evidence of financial crisis causing the structural destruction of U.S economy, making the recent unemployment levels invulnerable to extra monetary accommodation. This issue’s literature is extensive, making its full review complex (Bruner, et. Al 1973) Moreover, tracking all recent recession in U.S from the time world war two took place, the rate of unemployment has reverted to pre-recession. Although the previous recession was strangely deep, there is minimal evidence of significant structural change in past years. Instead of accrediting the gradual recovery to long run structural factors, growth can be seen being held presently by many headwinds. First, as much as the housing section has revealed some indicators of improvement, activity of housing stays at lower levels and its contributing lesser to recovery than would usually be expected at the cycle stage. Secondly, fiscal policy, both in the local, federal and state levels, has turned out to be a vital force for economic growth pace. Without standing some previous tax revenues improvement, local and state governments face fixed budget circumstances and continue cutting real employment and spending. Real purchases decline at Fed level. Uncertainties on fiscal policy, particularlyabout resolution of debt ceiling lifting and fiscal cliff, are seemingly also restrictive activity, though the scales of effect are difficult to judge. It’s serious that policymakers have made credible plans that set the budget of the Federal on a maintainable trajectory in longer and medium runs. Nevertheless, policymakers should have precautions to avoid a fiscal contraction which is dangerous to the recovery. Thirdly, stress in financial and credit markets continue restraining the economy. Prior to recovery, limited availability in credit was a vital factor in slagging growth, and constricted borrowing setting for small businesses and potential homebuyers remain problematic today. Previously, a main source of finance stresses has been not been certain about Europe’s development. These stresses are a problem for Europeans. However, through financial linkages and global trade, European effects on U.S are substantial. Some of recently proposed policies in Europe are very constructive and from my point of view, I propose pushing ahead policy initiatives for a resolution of the crisis. In the use of Fed reserve’s tools like balance sheet for attaining its mandated goals of price stability and maximum employment, the committee has majored on the long term security acquisition – particularly, agency securities and treasury, which are the main kinds of securities which the government is allowed to purchase under the Fed reserve act. A mechanism via which the purchases are thought to affect the government is through portfolio balance that has its basis on notions by famous economists inclusive of James Tobin, Franco Modigliani,Milton Friedman, Allan Meltzer and Karl Brunner.The main premise underlying the criteria is, for many reasons, various financial assets are imperfect substitutes in the portfolio of investors. For instance, institutional investors meet regulatory restrains on the kinds of securities that can be held by them. The retail investors are reluctant in holding some kind of assets as they involve high transactions cost and high information cost. Moreover, some assets contain risk features that are costly or difficult to hedge. Faulty asset substitutability insinuates that supplies changes of different assets accessible to private sectors may interfere with the yields and prices of assets. Hence, Federal Reserve purchasing of mortgage securities, for instance, should lower yields and raise prices of the securities. Furthermore, as private investors do the rebalancing of their portfolios through replacement of mortgage sold government with assets, the assets prices they purchase should increase and yields deteriorate as well. Increasing asset prices and decreasing yields ease entire conditions of finance and boost economic activity via channels same as the ones of conventional monetary procedure. Following this reasoning, it was suggested that long term security purchases by the Fed at the time of great depression would have aided the economy of U.S to recover in spite of the fact that short term levels were nearing zero. Others argued that purchasing long term securities in large scale would resolve the deflationary trap. Purchases of assets in large scale can impact financial situations and the wider economy through various channels. For example, they can give signs of the intent of the central bank to follow a persistently accommodative policy stand than recent thought, hence decreasing the expectation of investors for future plans of federal fund levels and putting extra downward stress on longer interest rates, specifically in real terms. Signaling like such can also raise business and household confidence by assisting to diminish worries about risks like deflation. At the time of stressful times, purchasing assets may improve the financial markets functioning, thereby easing conditions of credits in other sectors. With space for more cuts with an aim to increase limits funds rate of the federal, towards the end of 2008 the government reserve initiated continuous purchase of assets in large scale. In November, the committee announced an initiative to purchase 600 billion dollars in an agency debt and MBS. In the early 2009, the committee expanded the purchasing program significantly, stating that they will purchase 1.25 trillion dollars of MBS agency, 200 billion agency debts and 300 billion treasury debts (Hancock, et. Al, 2011) . The purchases were accomplished, with little adjustments, at the start of 2010. Toward late 2010, the committee stated that it will open up the securities of Federal Reserve by buying an extra 600 billion dollars of long term securities for some time ending in 2011. Back in the recent past, the committee injected a variety on its prior purchase programs called Maturity Extension Program (MEP), where by the government would buy 400 billion dollars of treasury securities in the long term and sell equal amounts to liquid treasury securities up to the end of June 2012. Subsequently, the committee prolonged the MEP towards this year’s end. By reduction of average securities maturity held by individuals, the MEP mounts extra downward stress on long term rates of interest and moreover eases entire financial conditions. Clarity in communication is often vital in central banks, although it can be particularly significant when economic situations call for more policy stimulus although the rate is at its efficient lower bound. Particularly, accelerative guidance that decreases expectations of private sectors regarding prospective rate of short term should make interest rates in the long term to decrease, resulting to accommodative financial situations. The government reserve has considered the use of such guidance to be a policy tool. As from the start of 2009 to 2011 June, the committee’s after meeting statement confirmed that economic situations stands a chance to warrant lower rates of Federal Reserve for a prolonged period. During the meeting in August 2011, the committee structured its guidance precisely by affirming that economic conditions will warrant that the rates of the Federal Reserve remain low to 2013. In the start of 2014, the committee extended the predicted period of low rates through the end of 2014. According to the language, a conditional promise and it’s a declaration by the committee’s collective judgment concerning the policy path that is expected to prove suitable, given that the objectives of the committee and its economic outlook. The committee members’ views concerning the probable scheduling of policy fixing stands for various factors balancing but the present forward guidance is widely consistent with remedies from a variety of benchmarks inclusive of maximum control methods and basic policy rules. Policy rules notifying the guidance link policy rates of interest tofamiliar determinants like output gap and inflation. Though many considerations also supports for planning keeping rates lower for a long period of time than expected by policy guidelines developed in the normal periods. The considerations are inclusive of the requirement of taking insurance against downward risk realization, which are specifically difficult to control when rates near the lower bound: the likelihood that, due to many unusual headwinds dragging the recovery, U.S requires more policy back up than usual and the requirement to compensate policy accommodation limits resulting from lower bound rates. If one may ask, has the guidance taken effect? The truth is over time, private forecasters and investors have pressed considerably when the expect rate of federal funds to start rising, furthermore, present policy expectation seem to be aligned well with the committee’s forward guidance. For surety, the changes made at the time the private investor expects the rates of the federal fund to start firming led to economic outlook deterioration that made the committee to bring in and prolong its guidance. Although the private investors’ reviewed outlook for policy rate appears to replicate an increasing appreciation of the way the committee anticipates supporting a bearable recovery. For instance, from 2009, foretellers who participated in the survey known as Blue chip have recursively marked down there forecasts of the rate of unemployment they anticipate to prevail when the committee starts to raise the aim for the rates of federal funds far from zero. Hence, the forward guidance of the committee may have taken a bigger willingness to uphold accommodation than the private foretellers had initially believed. The market prices financial behavior at the time of forward guidance changes is dependable on the perspective that it has had an effect on policy expectation. The economy of the United States has changed. Central banks have become fore actors in stabilization of whole economies and financial systems, normally in the spotlight. Many exceptional results and actions have been taken. A major depression was avoided by central bank taking decisive steps to solve the crisis. Even though, the economy of U.S is still changing. Central banking and monetary policy will not face any other crisis as the great depression. The crisis made the U.S to learn much as it came along with questions that need to be answered. The answer to these questions was forecasting on how the U.S economy’s central banking would be like when the economy reinstates its normalcy. The IMF has decided to debate on the “new normal” one of their main responsibilities. The main reason is because there questions that come from individuals time to time and if not answered they turn out to be pressing issues. To keep the tension away, there should be research and investigations from monetary authorities, think tanks in this field and invite more people to forecast on the monetary policy future. Most of expertise and knowledge are with the consumers and individuals who depend on the economy. IMF’s only contribution is knowledge across the country, experience in the organization of collaborative efforts internationally, and the knowledge of viewing economic policy in a bigger picture. For the issues to be solved amicably, individuals together with monetary authorities should work together to make the economy a better place in terms of finances. The task will be challenging to achieve but through collaboration and working hard to disseminate it will see United States thrive Conclusion In my early experience as a student of economics, I read a speech that contained monetary policy options when the interest rate of the short term policy is nearing its lower bound that is effective. By then my reaction was on some assertions that the monetary policymakers were fixed that they could not do anything as the rate of federal funds had drawn towards zero. My argument was that, in the contrary, policy is still has its effect as it draws towards the lower bound. With many years of involvement with both traditional and non-traditional tools both in other developed economies and in U.S, the knowledge of hoe these policy works is well known to us. It is clear, with the basis on this experience that such tools are always effective and that, if not present, 2007-2009 downturn would have been worse and the present recovery would not have been faster than it has taken place. Form my review in this paper, it can also be confirmed that such policies are not easy in application, with the prior experience we have. The estimations of these policies’ effect on inflation and economic activities are not certain and the use of these policies entails cost past the ones related to policies that are more standard. As a result, the bar for utilization of such policies is on the higher side compared to other policies. Moreover, in the current context, non-traditional tools share monetary policy limitations more generally. By itself, monetary policy is not in a position to achieve what a wider and balanced economic tools set can achieve, specifically, it is not in a position to neutralize the financial and fiscal risks that the state faces. Certainly, it cannot perfect economic results. As an assessment of costs and benefits of various approaches is carried out, there should not be any assumption of daunting economic obstacles that face U.S. Stagnation of labor market specifically is a big concern not because of huge suffering and human talents’ waste it has, but due to high rates of unemployment, there will be wreckage in the economy’s structural damage that may affect the nation for a long period. For the past 5 years, the government reserve has worked to assist economic growth and improve job creation and it’s vital to attain more progress, specifically in the market of labor. Taking into consideration the limits and uncertainties of policy tools, the Fed will give extra policy accommodation as required to boost economic recovery and improve sustainability in the labor market situations in terms of price stability. Works Cited Working Mother. October, 2003.190 pages, Vol. 26, No. 8ISSN 0278-193X Published by Working Mother Media Denis Ouellette. NEW$ & VIEW$ (22 JANUARY 2014). Posted on January 22, 2014 Baker, Scott R., Nicholas Bloom, and Steven J. Davis. "Measuring Economic Policy Uncertainty (PDF),” working paper, June (2012). Economic Policy Uncertainty, website. Bernanke, Ben S. "Reflections on a Year of Crisis," speech delivered at "Financial Stability and Macroeconomic Policy," a symposium sponsored by the Federal Reserve Bank of Kansas City, held in Jackson Hole, Wyo., August (2009). Brunner, Karl, and Allan H. Meltzer (1973). "Mr. Hicks and the Monetarists," Economical, vol. 40 (February), pp. 44-59. Congressional Budget Office.Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013. Washington: CBO, May. (2012) Hancock, Diana, and Wayne Pass more. "Did the Federal Reserves MBS Purchase Program Lower Mortgage Rates?" Journal of Monetary Economics, vol. 58 (July), (2011) pp. 498-514. Read More