Question

23. What does it mean when economists say that the Fed has attempted to "normalize" monetary policy after the Great Recession?

a. The Fed has tried to use monetary policy to restore the unemployment rate to its normal full employment rate of around 5 percent.

b. The Fed has tried to use monetary policy to raise excess reserves back up to normal prerecession levels.

c.The Fed has tried to make all of the monetary policy actions used during the financial crisis a normal part of the monetary policy tool kit.

d. The Fed has tried to use monetary policy to bring interest rates back to the historically normal range of 3 percent or higher.

24. The Fed's normalization plan for monetary policy included...

a. raising the federal funds target rate.

b. raising the interest rate paid on excess reserves.

c. using repos to insure the adequate excess reserves in the banking system.

d. raising the reserve ratio on deposits to soak up the excess liquidity in the system

Answer 1

Answer to Q. 23:

The Great Recession (2007-2009 approx) has affected the US Monetary Policy in a major way. After the recession, the Fed's balance sheet was growing in size (more than 4 times the pre-recession levels) as the Fed was involved in Quantitative Easing (QE); i.e. the Fed was purchasing assets (Treasury Debt, Mortgage Backed Securities, Agency Securities etc.)

Quantitative Easing is an expansionary monetary policy to stimulate the economy, which was much needed due to the Great Recession and to increase liquidity and money supply in the market. Generally, central banks also resort to cutting interest rates to stimulate the economy and encourage growth, which the Fed promplty did.

Post 2009, interest rates were cut down and brought to 0 to 0.25% levels. The nominal interest rates could not be cut to below 0% to stimulate growth making the interest rates rangebound i.e. restricted to 0%. As the Fed's balance sheet kept on ballooning, the Fed could not implement monetary policy in the same way it did in the pre Great Recession period.

Hence, the Federal Open Market Committee (FOMC), in its' Policy Normalization Principles and Plans proposed a program in which the Fed's balance sheet size be reduced and also allow the Fed to depart from the zero interest rate policy (also referred to as ZIRP), which is called as 'liftoff', which can be achieved only by way of reduction in the Fed's balance sheet size.

Hence, the answer is "d. The Fed has tried to use monetary policy to bring interest rates back to the historically normal range of 3 percent or higher."

Answer to Q. 24:

Using the same explanation given in Q23, the answer is "a. raising the federal funds target rate."