Question

How does the Fed's current monetary policy approach compare to the unconventional monetary policies undertaken during the 2008 Financial Crisis?

Answer 1

Monetary policy in the United States comprises the Federal Reserve's actions and communications to promote maximum employment, stable prices, and moderate long-term interest rates--the economic goals the Congress has instructed the Federal Reserve to pursue.The Federal Reserve's three instruments of monetary policy are open market operations, the discount rate and reserve requirements. Open market operations involve the buying and selling of government securities.In September 2020, the Federal Reserve maintained its target for the federal funds rate at a range of 0% to 0.25%. The last time the Fed cut interest rates to this level was December 2008.As the Federal Reserve conducts monetary policy, it influences employment and inflation primarily through using its policy tools to influence the availability and cost of credit in the economy.And the stronger demand for goods and services may push wages and other costs higher, influencing inflation.The Federal Reserve's (the Fed's) responsibilities as the nation's central bank fall into four main categories: monetary policy, provision of emergency liquidity through the lender of last resort function, supervision of certain types of banks and other financial firms for safety and soundness, and provision of payment system services to financial firms and the government.response to the 2007-2009 financial crisis and the "Great Recession," the federal funds target was reduced to a range of 0% to 0.25% in December 2008—referred to as the zero lower bound—for the first time ever. The recession ended in 2009, but as the economic recovery consistently proved weaker than expected in the years that followed, the Fed repeatedly pushed back its time frame for raising interest rates. As a result, the economic expansion was in its seventh year and the unemployment rate was already near the Fed's estimate of full employment at the time when it began raising rates on December 16, 2015. This was a departure from past practice—in the previous two economic expansions, the Fed began raising rates within three years of the preceding recession ending. The Fed then raised rates in a series of steps to incrementally tighten monetary policy. The Fed raised rates—by 0.25 percentage points each time—once in 2016, three times in 2017, and four times in 2018.The Fed's decision to reduce rates can be evaluated in terms of its statutory mandate. Based on the maximum employment mandate, tight labor market conditions did not support the series of rate cuts, considering monetary policy was still slightly stimulative—adjusted for inflation, rates were close to zero even before they were cut. The unemployment rate has been below 5% since 2015 and is now lower than the rate believed to be consistent with full employment. Other labor market indicators are also consistent with full employment, with the possible exception of the still-low labor force participation rate.With regard to its mandate, the Fed believes that unemployment is currently lower than the rate that it considers consistent with maximum employment, and inflation is running slightly below the Fed’s 2% goal by the Fed’s preferred measure. Monetary policy is still considered expansionary, which is unusual at this stage of an expansion, and is being coupled with a stimulative fiscal policy (larger structural budget deficit). The decision to cut rates in 2019 was controversial. The Fed justified the cut on the grounds that risks of a growth slowdown had intensified and inflation was still below 2%. But it also argued that the economy was still strong, and some of the risks to the economy, such as higher tariffs, had not yet materialized at the time of the decision. Overly stimulative monetary policy in a strong expansion risks economic overheating, high inflation, or asset bubbles.Normally, the Fed conducts monetary policy by setting a target for the federal funds rate, the rate at which banks borrow and lend reserves on an overnight basis. In light of increased economic uncertainty, the Fed then reduced interest rates by 0.25 percentage points in a series of steps beginning in July 2019.Information available last summer indicated that residential construction remained on a downward trend, the labor market had weakened further, and industrial production had declined. Although aggregate output was reported to have expanded in the second quarter, financial market developments suggested that the economy would likely come under considerable stress in the near future--in particular, tight credit conditions, the ongoing housing contraction, and the rise in energy prices were expected to weigh on economic growth over the subsequent few quarters. Core consumer price inflation remained relatively stable, but headline inflation was elevated as a result of large increases in food and energy prices.When a nation's economy slips into recession, these policy tools can be operated in reverse, constituting a loose or expansionary monetary policy. Interest rates are lowered, reserve limits loosened, and instead of selling bonds in the open market, they are purchased in exchange for newly created money.After the federal funds rate target was lowered to near zero in 2008, the Federal Reserve has used two types of unconventional monetary policies to stimulate the U.S. economy: forward policy guidance and large-scale asset purchases. These tools have been effective in pushing down longer-term Treasury yields and boosting other asset prices, thereby lifting spending and the economy.While conventional policy employs a short-term interest rate to affect financial conditions and the economy, unconventional monetary policy uses other tools to do so. The Fed employed forward guidance and quantitative easing as these unconventional policy tools (Kuttner 2018).Unconventional monetary policy occurs when tools other than changing a policy interest rate are used. These tools include: negative interest rates. extended liquidity operations. asset purchases (quantitative easing).Although forward policy guidance has proven to be a very useful policy tool, it’s not a perfect substitute for the kind of monetary stimulus that comes from lower interest rates. One issue is that, for the forward guidance policy to work as desired, the public has to believe that the FOMC will really carry out the policy as it says it will. After decades of using the fed funds rate as the main tool of monetary policy, Fed policymakers have plenty of confidence in this instrument. We know it works and we’re pretty good at estimating how much it works. By contrast, with unconventional monetary policies, we’re in waters that have not been extensively charted. We don’t know all the consequences. There is uncertainty about the magnitude of the effects on the economy, as I’ve already discussed. In addition, there is a concern that these policies carry with them risks of unintended negative consequences. ....thank you......