Question

I need a response to my peers discussion post

The Federal Reserve uses its various tools to end the recession in an economy. Federal reserve mainly uses open market operation which includes buying and selling of government securities by the Fed to affect the supply of money. To control recession, Fed buys government securities in the open market which increases the money supply in the economy and helps to overcome the recession phase. This improves the economy in time when it is required. Fed can also use its reserve requirement ratio, discount rate, etc to increase the supply of money in the economy.

So, Federal reserve is effective in ending the recession and stimulating a recovery in a timely fashion.

The 2008 financial crisis in the US forced the fed to adopt certain measures from time to time to protect the economy from falling into a deep recession. One of the measures was the purchasing of mortgage backed securities. The purchasing of these securities was a part of the quantitative easing (QE) method adopted by the Fed to increase the supply of money in the economy and reduce mortgage interest rates. These securities were backed by government sponsored enterprises-Fannie Mae and Freddie Mae. The strong backing of securities by government agencies led to an increase in the support to housing markets and an increase in demand for houses by increasing the purchasing power of the consumers.

Let's understand first that the total sum of currency in circulation and in bank deposits at Federal Reserve Banks is known as Monetary Base.

Under normal circumstances an increase in Monetary base should increase the inflation as rapid surge is due to accumulation of bank reserves. Now the purchase of any essay by Federal reserve bank without any other action which offset the action leads to increase in FRB's balance sheet assets and its liabilities. Definitely it will be difficult to maintain the price stability and will depend on the size of the balance sheet. Thus role of the FRB will be to reduce the size of the Balance sheet by control of following factors:

a. Term of its loan portfolio

b. quality of its assets.

c. market need for repurchasing financial instruments

The power to stabilize the economy lies in the hands of FRB and is not dependent on banking system. FRB is the unit in the whole Financial system which can control the bank reserve positively or negatively. Giving loan by bank A and deposits of same amount in Bank B leads to no change in FRBs reserves. So when monetary base increases FRB has to drain money from the economy so that there is no increase in inflation.

Answer 1

There is no doubt in the fact that the Federal reserve aims at upholding the situation of a country from any financial crisis that the nation experiences and I will agree with the post to a great extent in this context but the process that the Federal Reserve uses is important and that is the method through which this change can be brought in. The year 2008 brought about a lot of measures to make the economy of the country better and improved because ideally the federal reserve relies or banks upon selling and buying of securities or government securities which makes the flow of cash stabilized and in control in the country during such phases of the economy. I will again state that the Federal Reserve played quite an important role ion this context as well when they actually relied on their methods which will bring them success and the quantitative method was the primary in this case as well.

I would like to mention that the federal reserve needs to play this role and continue the same so that they can improve the economy of the country at times of need and it is better for them to handle such situations because they are the ultimate organization in this context.