Question

1) Recently, has the Fed chosen to pursue expansionary monetary policy or is it implementing contractionary policy? Why is this the case and what does it tell you about how the Fed views the current state of the economy?

2) Suppose it is 2014 and the board of governors believes we are about to enter into another recession. Based on where the Federal Funds rate already was at that time, what problem might the FOMC encounter when they attempt to stimulate the economy by purchasing t-bills?

Answer 1

Answer to Question 1)

The Federal Reserve has recently adopted an expansionary monetary policy. The same is done with the view that the corona virus pandemic will cause a deep recession and demand and supply in all economies will begin to decline at a fast rate.

Over the months, the world economy has been bad hit by the virus. The countries do not have enough capital to be able to match the reduced demand and the need of the hour thus is to create more money in the economy.

This is done by expanding business activities to ensure long term success of the economy. To achieve this, the Federal Reserve has taken numerous measures such as reducing the cash reserve requirements which is the minimum amount of reserves which commercial banks must hold with the Federal Reserve to 0. The end result of this is that commercial banks can freely lend more money and the economy can expand.

Further, other measures have also been initiated like reducing the rate of interest at which the Federal Reserve grants loans to commercial banks to 0.25% The end result of this is that liquidity in the market increases and banks are able to supply the market with excess cash.

Consumers and investors have no incentive to keep cash in their pockets and prefer spending or investing to ensure that they get maximum for their money. The Federal Reserve can also purchase Treasury Bills to increase the total reserves by a similar amount.  

A contractionary policy is just the opposite of what has been described, and it is performed when inflation is too high in the economy.

Answer to Question 2)

When the Federal Reserve Initiates buying of treasury bills it is often known as Qualitative easing. It is done to ensure that the total availability of funds can be increased in the market place.

In 2014, the Federal Interest rates were extremely low at 0.15% increasing the demand for capital. At this period when the Federal Reserve engages in buying of treasury bills, the total currency in circulation becomes extremely high. During this period, the Federal Reserve risks devaluation of the currency, as the same is high in supply and the demand for it goes down in the international markets. Therefore, imports become more expensive, and lesser returns come in through exports in the country.

Thus, we can conclude by saying, that treasury buying in a market where, interest rates are already low, risks the currency of devaluation and hyperinflation in an economy.

Please feel free to ask your doubts in the comments section.