Question

2. After the 2008 Global Financial Crisis (GFC) the Central Bank of the United States and the federal government both attempted to stimulate the economy.

a. What caused the GDC and what fiscal policy actions can the federal government take to stimulate the economy? Be sure to define the key terms and the macro models you used to explain the outcomes.

b. Explain what actions the Central Bank took to stimulate the economy. Again, be sure to define key terms and the macro models you used to explain the path to economic growth.

Answer 1

a) The GFC in 2008 was mainly caused by financial market deregulations . The Gramm- Rudman Act allowed banks to participate in trading profitable derivatives . These derivatives caused surge in the demand for mortgages . Slowly the subrime mortgage crisis spread and hit the housing sector badly . Prices of houses began to fall steeply . So banks got into trouble and stopped lending each other . They did not want to carry the burden other bank's worthless mortgage as colaterals . This finally led to the major crisis .

Fiscal stimulus was required to drive the economy out of the crisis . Tax cuts and government spending or in other terms expansionary fiscal policy should be implemented at times of recession . This helps to stimulate the growth in the economy . But the size of the policy measure or the effects cannot be said certainly .

b) The FED's response was to stimulate maximum employment , price stability . FED reverted to the open market operations to increase liquidity in the banking sector . It also put downward pressure on long term interest rates , tried to buy back mortgage backed lending by other agencies . The main aim of FED was to implement an expansionary monetary policy to bring stability .