Role of Federal Reserve System in Overcoming the Financial Crisis of 2008 - Essay Example

Economics Federal Reserve System Federal Reserve System or FED is basically a central banking system of USA that created on December 1913, due to severe financial conditions. Now this is playing different functions for boosting the USA economy those are: Working as a central bank for United States Address about the financial severe problems Regulates and instruct the other banking systems Control monetary policy through manage the money supply in the economy Provide the financial facilities to other financial institutions, US government to strengthen the economy of US Provide the major facility of exchange of payments in the different regions. It also play a role in maximizing employment, stability of price level as well as long term moderate interest rate in the economy. Open market operations in which selling and purchasing of government securities occurs by the FED. These operations are in the control on the FOMC. So it basically plays a role in providing largest payment system in the world. Every day many transactions occur between the different sellers and purchasers of goods in term of US dollar. It also maintains millions of accounts as well as performing a role in settling and clearing different financial institution payments through intermediaries. FED play a vital role in providing the facility of financial services to depository institutions like distributing currency and coins, transfer funds and securities through clearing house system and collecting checks. FED Role in 2000 on US Economy In 2000 the US federal budget was in surplus that was $236 Billion and more than the preceding years those showed the deficit condition. This surplus then used buy back privately held government debt over the last five years. Due to rising in the oil prices that time CPI inflation rate increased from 2.5% to 3.45%. The unemployment rate of US in 2000 was 4% that showed steady pattern that lead to labor market are extremely tight that also increase the aggregate demand of goods and also wages improved as well as price level increased by FED that time. Another biggest international upset of 2000 was continues fall of euro against dollar, that was 0.86 dollar per euro. Due to strengthen of dollar US face current account deficit improved from $78.9 to $106.14. It also affected the trade position in services. That time fed increased the interest rate to overcome the persistent level of inflation. So that time economy was going slow down due to FED’s tightening monetary policy. Role of FED in the Last 4 Years In the last four years FED play a vital role in the economic indicators of USA economy. In 2009 first time in the history FED maintain the discount rate on .25 that was in 2008 so there arise no change. As well as it remained same in last 4 years from 2009 to 2012 in US. FED uses this strategy to control the supply of money that influences the inflation and interest rate on the economy. In 2009 the credit card act is announced FED that means a company cannot change the rate on the existing balance of a person.FED also improving the reserve requirement every year that is helpful to control the inflation but it is also slowed the growth of economy. The reserve requirement was about 67 billion in 2009, 74 billion in 2010, and 100 billion in 2011 that is reached on 104.45 billion in 2012 according to Federal Reserve of US. Due to highest and severe financial issue of US debt that aroused in May 2011 and increased than 14$ trillions, FED decided to depreciate the US dollar in the economy. This financial problem came due to high government expenditures of US and less tax revenue. Money supply in US (M0) that includes coins and notes as well as asset those are easily convertible in money also showed upward trend from 2009 to 2012. Like it increased from 1700000 USD millions to 2643310 USD million in 2012. Bank lending rate that is set by FED is constant from 2009 to 2012 that is 3.25%. FED’s Tool in Gaining Macroeconomic Objectives Open Market Operations Fed plays an important role to maintain the US economy through different tools. Open market operation in which selling and purchasing of government securities occurs that is helpful for the monetary policy. The FOMC purchase government securities from banks to increase the money supply in the economy. Through this more money available in the market for lending purpose as well as capital will be cheaper so, the greater investment takes place and economic growth will be in stable form or improved. As well as unemployment rate reduced and many jobs will available in the US. But now a day US mainly focus to control the inflation for this FOMC selling securities and increased the interest rate. Because due to inflation, cost of production increased that also increased the demand of loan able funds, for this reason FED increased the interest rate. Reserve Requirements Through high reserve requirement FED’s hold more money in the form of reserve that reduces the lending power of it as well as money supply shrinks and slower the economic growth that also reduces the price level. Due to deepen the growth unemployment also rises in the US. So, in the US, FED used mostly contractionary monetary policy to control the inflation and some time give focus on expansionary monetary policy to attain stabilize growth and reduce the unemployment. Discount Rate Fed also control inflation through discount rate which is also called as borrowing rate. Increase in discount rate make expensive to borrow loan from the FED as well as reduce the money supply in the economy. This also promotes the short term interest rate that slowdown the economy. Less output level reduce the requirement of workers and their increased the unemployment. Moral Suasion The tactic that Fed occasionally used to persuade (not by force) financial institutions into adhering to policy is called moral suasion. Such procedure includes private meetings with the directors of the banks, vague threats or increased in inspection’s strictness. An example of use of this tool is used by Fed is when its Chairman addresses on the financial markets and his view on the entire economy can send financial markets flying or falling. A most important problem regarding this Fed’s tool is that it is unpredictable. Even though, in past years the Fed has rarely urged bankers to do against their own benefit. Current Situation of US US major indicator of unemployment is moving downward slowly, the current unemployment rate recorded 7.8% that is similar to the last year figures this shows that more than 300000 jobs on monthly basis required to maintain the target. As inflation rate is now 2% in the US economy so FED’s chairman decided to introduce the ease monetary policy that is helpful for this recovery pattern but it can also show the trouble because Bernanke has tripled the money supply that can be increase the inflation in future. In the US financial crisis now cleared that’s the reason, FED reduced the federal fund interest rate on overnight loans that is about ?% and it want to take it on 0% but that is not better for future aspect of US economy. FED also gives the announcement of open ended securities treasury and agency mortgage backed securities. These purchases also designed to lower the long term interest rate that is beneficial for the investment and borrowing methods. So FED balance sheet has more than doubled in this year about 2% due to shortfall of funds rate in US economy. Suggestion Related to the US Economy for the Next Two Years US is facing many economic and financial trouble in 2013 the main issue is the unemployment rate that is increasing day by day so it is important to take a safety measure for the reduction of unemployment by the FED. They are selling their asset and taking on massive debt to sustain the living standard of the citizen so FED should also look on this severe issue to reduce the debt through purchasing their asset that will increase the money supply in the economy as well as consumer spending. This policy can overcome the unemployment issue and job creation will increase. Short term rates also reducing by FED , that is beneficial for the US but according to the economic situation it has to reduce to 0 in the next one or two years through this reduction economy can reduce the unemployment up to 6.5% or below it in the future. So, Bernanke has to take a policy of purchasing asset that will reduce the borrowing cost as well as encourage the risk taking. Bernanke should also be focused on the interest rate because too more reduction in this, US economy can face the high inflation rate that will affect the unemployment and economic growth. Through these policies economy can fully recover from the recession in 2020 and labor force will be return on full employment level. Economic Stimulus In the past years the economic stimulus efforts included the more government spending on the citizen of US for their better and protected future. Because more spending from government areas, can more stimulate the economy. But due to much spending and high buying behavior US faced the debt and its debt to GDP ratio was more than 90%. US government increased the spending to providing the Medicare benefits, transfer payment, housing benefits and to boost the economy out of recession. (Labonte 02) Traditional Policies There are three different groups of tools that Fed used traditionally. The 1st group includes the tools that are related to the role of the central bank as “the lender of last resort.” This includes the policies related to the short-run liquidity to banks and other financial and depository institutions. This category includes Term Auction Facility (TAF), traditional discount window, Term Securities Lending Facility (TSLF), and Primary Dealer Credit Facility (PDCF). The 2nd set if tools include the direct liquidity to investors and the borrowers in the main credit market is the 2nd group of tools. This category includes Commercial Paper Funding Facility (CPFF), the Term Asset-Backed Securities Loan Facility (TALF), Money Market Investor Funding Facility (MMIFF), and Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF). (N.p. )The 3rd group of traditional tool of Fed for helping the credit market is the open market operations which involves the sale and purchase of the Treasury securities of the United States. According to traditional policy, the Fed carry out OMO by fixing the target of rate of interest that it considers will let it to accomplish its legal authorization of “steady prices, maximum employment, and reasonable long-run rates of interest.” In the recent past, as a result of the financial crisis, the Fed used its traditional tools for injecting credit, reserves, and liquidity into the banks collectively, in addition to make lends to other non bank firms. As financial situation return to normal, loans were pay back with interest. Non Traditional Efforts During the past few years, the liquidity problems remains because of the reduction of the fed funds rate, it seemed that the traditional method was not working. In addition to this, another problem with the monetary authorities is that the liquidity offered to the banking industry was not reaching other divisions of the financial system. Therefore it was not possible to provide additional monetary stimulus only by utilizing traditional tools of monetary policy. To avoid this crisis, the Fed decided to utilize nontraditional policies in order to provide extra monetary policy stimulus. According to the Chairman of Fed, Mr. Ben Bernanke, "The Fed will present other policy adjustment as required." He further added that "Since the crisis situation has reached to its extreme as well as the Fed funds rate at its lower bound, therefore in order to support the recovery procedures the Federal Open Market Committee has to use non-traditional policies.” These non-traditional policies by the central bank of the United States include the buying in 2.3 trillion dollars in bonds in 2 rounds to back the economy through quantitative easing. The final round of purchasing asset ended in 2011. Last year the Fed launched more policies for buying bond, in a process called as QE3. Work Cited Labonte, Marc. "Monetary Policy and the Federal Reserve: Current Policy and Conditions." Congressional Research Service (2013): n. pag. Web. . N.p., Web. . Read More