Question

What impacts did the Fed’s monetary policies have on the monetary markets from 2007-2011? Explain.

Answer 1

In the second half of 2010 and early 2011, economic activity in the United States increased at a moderate pace, on average,. A number of key economic activity measures weakened in the spring and early summer in comparison to the readings reported in late 2009 and the first part of 2010, raising concerns about the recovery's sustainability. In view of these developments and in order to put economic recovery on a firmer footing the Federal Open Market Committee (FOMC) provided additional monetary policy stimulus in the second half of 2010 by reinvesting major repayments of its Agency debt and mortgage-backed securities holdings into longer-term Treasury securities.

Financial market conditions strengthened significantly in fall 2010, partly in response to real and planned rises in accommodation in monetary policy. Moreover, the tenor of incoming economic news grew somewhat stronger later in the year, and the downside risks to economic growth seemed to recede. Nevertheless the labor market has only slowly improved. Employment increases were small, and while the unemployment rate dropped significantly in December and January, the slack margin on the labor market remains high. While, given rapid rises in commodity prices, expectations for longer-term inflation remained stable

Long-term returns on Treasury securities decreased in the summer and early autumn, reflecting in part the possibility of additional monetary policy stimulus, but subsequently increased as economic prospects strengthened and market expectations of the eventual scale of FOMC Treasury purchases updated. Yields on Treasury securities remained relatively low on average, despite some uncertainty. Medium-and long-term inflation compensation from inflation-indexed Treasury securities has increased since the summer as concerns about deflation have eased, although those measures have remained within historical ranges.

This improvement reflected, in part, the Federal Reserve's additional monetary policy stimulus, as well as increasing investor confidence in the sustainability of the economic recovery. While yields on Treasury securities have risen somewhat, on net since mid-2010, yields on corporate investment-grade bonds have changed little at low levels, and yields on speculative-grade bonds have declined. Price indices broadly rose on equity markets, backed by strong corporate earnings and a more positive economic outlook. Commercial banks reported having relaxed some of their lending standards and conditions, while lending standards have generally remained tight

Monetary policy tightening in the EMEs has likely been tempered by uncertainties about the pace and durability of the economic recovery in advanced economies, which remain an important source of demand for the EMEs. Furthermore, the exit from welcoming positions was complicated by the return to these economies of private capital flows. Capital inflows seem to have exerted some upward pressure on currencies and raised concerns about the potential for asset prices to overheat. To date, EME authorities have implemented a variety of strategies to cope with increased capital flows, including foreign-exchange intervention