Question

Explain the impact of the new monetary policy actions on individuals and businesses within the economy by integrating the macroeconomic data and principles.

Specifically, what was the result of the expansionary monetary policies in place from 2000 - 2010 ?

Answer 1

Explain the impact of the new monetary policy actions on individuals and businesses within the economy by integrating the macroeconomic data and principles. ?

Ans …

Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.

Usually when the monetary policy reduces the interest rates then the lending activity of the banks increases or the individuals and the business increase their borrowing activities. The borrowing by individuals and businesses increases because this is the time when at low cost of capital the individuals and business think about increasing their consumption (in case of individuals) and production activities (in case of businesses). In short, firms carry out investments such as buying new machinery, opening new plants and procuring more production units. On the other hand the households indulge in buying cars, homes, more luxury goods or other things. This overall leads to an increase in GDP.

Specifically, what was the result of the expansionary monetary policies in place from 2000 - 2010 ?

From 1994 to 2000 real GDP increased, inflation was under control and unemployment dropped to below 5%, resulting in a rising stock market known as the Dot-com boom. The Fed raised interest rates six times between June 1999 and May 2000 in an effort to easy the economy’s shock to the bubble’s burst. The actual burst came in March 2000 when the NASDAQ crashed. Growth in gross domestic product slowed noticeably in the third quarter of 2000.

While Greenspan's role as Chairman of the Federal Reserve has been widely discussed there is also the argument that Greenspan's actions in the years 2002–2004 23 were actually motivated by the need to take the U.S. economy out of the early 2000s recession.

The National Bureau of Economic Research, or NBER, is a private, nonprofit, nonpartisan organization charged with determining economic recessions. The NBER determined that a peak in business activity occurred in the U.S. economy in March 2001.

A peak marks the end of an expansion and the beginning of a recession. Thus determination of a trough date in March 1991 marks the beginning of an expansion and it ended in March 2001 giving rise to the recession. The U.S. economy was in recession from March 2001 to November 2001, a period of eight months at the beginning of President George W. Bush’s term of office. During this period economic conditions did not satisfy the common definition of recession, which is a fall of a country’s real gross domestic product for two or more consecutive quarters.

This has led to some confusion about the procedure for determining the starting and ending dates of the recession. The NBER’s Business Cycle Dating Committee, or BCDC, uses monthly, rather than quarterly, indicators to determine peaks and troughs in business activity, as can be seen by noting that starting and ending dates are given by month and year, not quarters. From 2000 to 2001, the Federal Reserve made consecutive interest rate increases. Using the stock market as an unofficial benchmark, a recession would have begun in March 2000 when the NASDAQ crashed following the collapse of the Dot-com bubble.

Other markets were relatively unaffected until the September 11, 2001 attacks, after which the DJIA was hit with one of the largest point losses in history. The market rebounded, only to crash again in the final two quarters of 2002. In the final three 24 quarters of 2003, the market finally rebounded permanently, supported by the unemployment statistics during this time period (see Figure 2). Through 2001 to 2007, the housing market across the United States fueled a false sense of security regarding the strength of the U.S. economy.

Housing prices peaked in early 2006, started to decline in 2006 and 2007. The Bernanke Era (2006-2010) On February 1, 2006 President Bush appointed Ben Bernanke as Chairman of the Fed. Bernanke is an advocate of a transparent Federal Reserve System. Bernanke was nominated for a second term by President Barack Obama on August 25, 2009.

His first months as chairman of the Federal Reserve System were marked by difficulties communicating with the media. An advocate of more transparent Fed policy and clearer statements than Greenspan had made, he had to back away from his initial idea of stating clearer inflation goals as such statements tended to affect the stock market. According to the NBER the ‘Great Recession’ began in December 2007.

The financial crisis is connected to irresponsible lending practices by financial institutions and the growing trend of securitization of real estate mortgages in the United States. The US mortgage-backed securities, which had risks that were hard to assess, were marketed around the world. A more broad based credit boom fed a global speculative bubble in real estate and equities, which served to reinforce the risky lending practices. The fragile financial situation was made more difficult by a spike in oil prices during 2007 and 2008 .

The emergence of Sub-prime loan losses in 2007 began the crisis and exposed other risky loans and over-inflated asset prices. With loan losses mounting and the fall of Lehman Brothers on September 2008, a major panic broke out 25 on the inter-bank loan market. As share and housing prices declined, many large and well established investment and commercial banks in the United States suffered losses, resulting in massive public financial assistance.

Real GDP started to contract in the third quarter of 2008 and continued to fall until mid-2009. The subprime mortgage crisis led to the collapse of the United States housing bubble. Falling housing-related assets contributed to a global financial crisis. The crisis led to the failure of many of the United States' largest financial institutions: Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers and AIG. The government responded with a 700 billion dollar bank bailout and a 787 billion dollar fiscal stimulus package.

The late-2000s recession was part of an ongoing global economic problem that began in December 2007 and took a sharp downward turn in September 2008. Monetary and Fiscal Policy respond to one another, which can produce policy conflicts.

Fiscal Policy is important in understanding the workings of monetary policy. Budget deficits can force monetary policy to monetize debt. Policy conflict over different objectives can produce sub-optimal outcomes.

Coordination between Fiscal and Monetary policy instruments made more difficult by independence of Central Banks. In times of crisis coordination is more important. The financial crisis led to emergency interventions in many national financial systems.

As the crisis developed into a genuine recession, economic stimulus became the most common policy tool. After implementing stimulus packages for the banking system, the U.S. announced its plan to relieve the economy.

The stimulus packages were brought about by the Emergency Economic Stabilization Act and Troubled Asset Relief Program or TARP. The Emergency 26 Economic Stabilization Act of 2008 was enacted in response to the subprime mortgage crisis authorizing the United States Treasury to spend up to 700 billion to purchase distressed assets and make capital injections into banks.

After congressional enactment, President George W. Bush signed the bill into law creating the Troubled Asset Relief Program (TARP) to purchase the failing bank assets (Ferguson & Johnson, 2009; Shachmurove, 2011). The government took significant amounts of portfolio risk in large financial institutions. The Treasury supported the government-sponsored enterprise and the deposits of money market mutual funds.

The FDIC has guaranteed the debt of large commercial banks and small industrial banks and has extended the coverage of insured deposits. TARP money added capital to the banking system. The scale of the intervention in credit markets was monumental.

The Federal Reserve, Treasury, and Securities and Exchange Commission took several steps in September 2008 to intervene in the crisis. To stop the potential run on money market mutual funds, the Treasury announced a 50 billion dollar program, on September 19, 2008, to insure investments, similar to the Federal Deposit Insurance Corporation (FDIC) program.

Part of the announcements included temporary exceptions that allow financial groups to more easily share funds within their group. In an effort to increase available funds for commercial banks and lower the fed funds rate, in September 2008 the Federal Reserve announced plans to double its Term Auction Facility to 300 billion dollars.

As of December 2008, the Federal Reserve had spent 1.2 trillion on purchasing numerous financial assets and making emergency loans in an attempt to stabilize the 27 financial crisis, beyond the 700 billion authorized by Congress from the federal budget.

This includes emergency loans to banks, credit card companies, and general businesses, temporary swaps of treasury bills for mortgage-backed securities, the sale of Bear Stearns, and the bailouts of American International Group (AIG), Fannie Mae and Freddie Mac, and Citigroup (System). The NBER announced in September 2010 that the 2008-2009 recession had ended in June of 2009, making it the longest recession since World War II (NBER).