Question

During the 2007-2009 financial crisis, the Fed had used non-conventional monetary policy tools to achieve their goals. Explain how each tool impacted the interest rate (short-term or long-term) or money supply or both.

Answer 1

The Fed had used few unconventional monetary policies to control the financial crisis of 2008.One main tool has been targeted assistance to financial institutions.The basic idea was to lend money cheaply to every financial institution to prevent further future bankruptcies.This increased the supply of money in the banking system. Another tool was Quantitative easing.It is also known as large scale asset purchasing.This means the federal government purchases a lot of long term debt issues.The last tool is forward guidance which tries to keep long term interest rate low.The idea is that if people think that interest rate will stay low for a long time they will borrow and invest more,

Quantitative easing means printing more money but the Fed does not print money so to say. Printing is the work of Bureau of printing so that when more money is printed ,people who want to withdraw money from bank will have money in cash.But money is mostly electronic. More money with Fed means the fed uses that money to purchase bonds from banks and more money is supplied . The supply of money increases steadily and helps the economy.Extra money created a lot of cash reserves with the Fed ie money which banks are to keep with Fed as reserves.The Fed then decided to pay interest on extra reserves to take out money out of the system.

The idea behind forward guidance is that people or business want interest rate to be low for a long time.Fed could inform the people that interest rate will be low for a long time.The Fed said that interest rate will be zero even when there is inflation of 2% in the economy.So the people started investing on houses and cars.