Question

Please answer the essay questions based on the following press release from the Fed (Release Date: September 21, 2011). You may want to find the original press release for the details. “To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate. “ a. The report claims that the proposed actions will put downward pressure on longer-term rates. Explain the mechanism through which these actions affect the long term interest rates. Also explain what effect will these actions have on the shorter term rates? b. Draw the yield curve based on the data on 09/15/2011 (use the actual data – Treasury website). c. Show the EXPECTED change in the yield curve if the Fed pursues the proposed action. Please re-draw the graph in section b and show the expected change in the yield curve on the same graph. d. Draw the yield curve based on the data on 10/31/2011 (use the actual data – Treasury website). e. Compare the graphs in sections b and d. Has the yield curve shifted as expected? You may want to draw the graphs b and d in the same graph. This way you will be able to observe the patterns more accurately. Please explain your answer. Minutes of the FOMC meetings is available at the Federal Reserve’s web-site. http://federalreserve.gov/newsevents/press/monetary/20110921a.htm http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

Answer 1

a) From the fed report we see that the economy suffers from a slowdown position due to which the central government plans to take up open market purchase of securities . This leads to a higher money supply inside the economy because government purchases from the public . Later when money suply rises the interest rates in banks fall down .Falling interest rates stimulate investments in the economy and increase AD . This helps in increasing production and employment to meet the ongoing demand in the economy. The short term interest rates will reduce a lot but in long term they shall become stable again with effective monetary and fiscal tools .

b) refer to figure .

d) The next yield curve is inverted yield curve that shows that the initiall yields offered fell but ever since 7 years bonds were introduced the yields started to rise majorly . This means initially bonds did not yield much returns but later with rise in years of maturity they increased.