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Federal Monetary Policy Analysis
The government policy of any country is usually a reflection of the economic processes that happen in both domestic and foreign markets. In the beginning of 2007, the US economy has started a period of economic recession (Isidore). However, it would be fair to say that the overall state of the economy before 2007 was bad enough to easily forecast the recession. As most economists believe, when recession started, Americans were already waiting for it.
The problems in the labor market revealed the overall recession of the economy in 2008. As Isidore notes, it typically takes a long time after the start of a recession to declare its start because of the need to look at final readings of various economic measures (para. 2). Therefore, economists have only claimed the 2007 recession in the middle of 2008. Already in 2008 it was clear that the financial markets of the US and other countries of the world will be affected by the recession of the US economy.
However, even these events have had longer routes. Zarroli saw the process of tightening of lending standards for consumers and businesses in the beginning of 2007 (para. 13). The interesting question is where the tightening came from. The purchasing power in consumer markets is primarily based on the real estate. Thus, it is fair to believe that it all begun even earlier in 2006 when real estate markets were in trouble. As Isidore observes, the reasons of the 2007 economic downturn, housing downturn, which started in 2006, is a primary cause of the broader economic malaise (para. 8)
Federal government played a crucial role in everything that happened with the economy prior to downturn and afterwards. The monetary policy, which has been applied in order to balance the dollar and cash circulation within the country, is now the subject of a major discussion among the economists. It is believed that the monetary policy was not effective due to its risky and challenging character.
The view that monetary policy can be ineffective during financial crises is quite popularly expressed among economists. Mishkin argues that the ease of monetary policy had no impact on interest rate growth and the cost of credit. Despite the fact that these instruments are the ones that have to be widely applied within the monetary policy, the direction that had been taken was wrong (Bernanke).
Moreover, the hardening of the banking sector spending played an opposite effect to the one that had been expected. In the view of some researchers including Mishkin, monetary policy cannot be ineffective as its primary role is to provide guidance during crises. As Mishkin believes, easing monetary policy during a crisis is counterproductive because it can weaken the credibility of the monetary authorities to keep inflation under control and thus be inflationary (2).
The whole policy of the Federal Reserve was based largely on the relation to the Great Depression of the 1930s. The aim was not to repeat the same mistakes from the past. Therefore, the monetary policy has been applied with consideration of the ways it worked in the early 30ies. However, due to the fact that the situation was different, the monetary policy did not work out the way it was expected. On the contrary, the attempts of the Federal Reserve to cut the fund rate have not led to the fast reaction from the side of financial markets. The signs of recovery were visible, but the process was very slow.
In this respect, Federal Reserve took another action to tighten financial markets and make them function again: Federal Reserve started buying securities from the stock market in order to heal financial markets within the US and in the rest of the world. These securities also included the agency and mortgage-based bond. This is viewed as a wise decision as the start of the crisis and economic downturn was closely tied to the real estate bubble and the instability on real estate markets in general. Mortgage loans had a direct relation to that process.
Finally, Federal Reserve took over the crisis management fully in the end of 2008, and by its actions was able to restore the work of financial markets. However, the decision to cut rates to almost zero and then start selling to the investors meant that the risk of inflation was in place. However, compared to other consequences that might have been happening, inflation was one of the less severe ones.
After the financial crisis, the results of the Federal Reserves monetary policy are widely discussed. Some economists still believe that the actions of the government were far from stabilizing. In the opinion of most economists, cutting the funds rate caused even more economic downturn than before without hitting the target of the policy the financial markets.
However, the fact that the crisis has been stabilized since Federal Reserve started buying securities is undoubtable. As Bernanke states in his speech right after the crisis, the policy has been successful; he believes that such policies can be effective, and that, in their absence, the 2007-09 recession would have been deeper and the current recovery would have been slower than has actually occurred (para. 36).
This is one of the most common conclusions that have been made since the Federal Reserve claimed the end of the crisis. The tasks, which had to be solved by the central bank, were solved efficiently. Despite the slow reaction from the financial markets, which can be one of the reasons why the crisis seemed so strange at the beginning, all instruments that had to be introduced by the government were introduced, and the problem with economic downturn was solved.
Of course, criticizing the actions of Federal Reserve is a simple action. However, it is really difficult to take decisions about monetary policy in the crisis condition. Standard monetary policy decisions can be taken every day. However, in the face of financial markets fall in October 2008, Federal Reserve had seen the ineffectiveness of the dropping fund rates and decided to support and heal the financial markets by attracting more value to them, i.e. selling long-term securities.
Finally, the cost of such monetary policy, which can result in rising inflation, is usually reflected as one of the methods of untraditional methods of monetary policy. As Bernanke further states, estimates of the effects of nontraditional policies on economic activity and inflation are uncertain, and the use of nontraditional policies involves costs beyond those generally associated with more-standard policies (para. 37). Hence, it cannot be said that the central bank knew the results of the policy implementation.
By its actions, Federal Reserve demonstrated great knowledge of how the financial markets operate in the US and in the entire world. For this reason, it is believed that the economic downturn was handled successfully.