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Easy money from the Fed?

The US economic recovery is slowing. As consumer and business confidence wanes, so there is growing talk of a double-dip recession. So what’s to be done about it? How can aggregate demand be boosted without spooking the markets?

One solution would be for a further fiscal stimulus. The one instituted in January 2009 in the depth of the recession has virtually worked itself out, with many short-term projects financed by the stimulus having come to an end. But any further stimulus would cause further worries about America’s balooning public-sector deficit, which already is predicted to be some 10.6% for 2010 (up from 1.1% in 2007).

The alternative is to use monetary policy. But, with the Federal Reserve rate already at between 0% and 0.25% (where it has been since the end of 2008), there is no scope for further cuts in interest rates. If monetary policy is to be used to give an additional boost to the economy, then further quantitiative easing is necessary. This is what the Federal Reserve decided to do on 10 August. As the Independent (see link below) states:

The US Federal Reserve decided last night to extend its $1.55 trillion programme of quantitative easing in an attempt to rejuvenate an economic recovery that the central bank admitted was turning out “more modest” than it expected.

The interest rate-setting Federal Open Market Committee bowed to calls from across the financial markets to extend its support, saying it would pump new money into the markets at a rate equivalent to about $200bn a year, and it left the duration of its efforts open-ended.

So how successful is this policy likely to be? The following articles look at the issues.

Articles
‘Light’ quantitative easing for slow US economic recovery New Statesman (11/8/10)
Fed sets the printing press rolling again to juice recovery Independent, Stephen Foley (11/8/10)
US Federal Reserve reveals plan to buy government debt Herald Scotland, Douglas Hamilton (11/8/10)
Some questions and answers on the Fed`s new policy Money Control (11/8/10)
Fed downgrades recovery outlook Financial Times, James Politi and Michael Mackenzie (10/8/10)
Fed acts as US recovery loses steam ABC News, Peter Ryan (11/8/10)
Top Fed Official, Warns Fed Risks Repeating Past Mistakes Huffington Post, Thomas Hoenig (11/8/10)
Austerity or stimulus? Some economists ha
The Fed must address Main Street’s credit crunch The Economist, Guillermo Calvo (15/8/10)
The Fed has options to lower real interest rates The Economist, Mark Thoma (15/8/10)
Fear of renewed recession in America is overblown; so is some of the optimism in the euro area The Economist (12/8/10)
Analysts’ view: Economists divided on effectiveness of Fed move Reuters (11/8/10)
If the Fed’s going to monetise debt, now’s the time to do it The Economist, Laurence Kotlikoff (13/8/10)
A former Fed official offers advice to Ben Bernanke The Economist, Joseph Gagnon (17/8/10)
America’s century is over, but it will fight on Guardian, Larry Elliott (23/8/10)

Federal Reserve documents
Press Release on monetary policy Federal Reserve (10/8/10)
Information on Federal Open Market Committee Federal Reserve

Questions

  1. What are are the arguments for using quantitative easing?
  2. Explain the process by which quantitative easing increases (a) narrow money and (b) broad money.
  3. How has the US and global economic situation changed since June 2010?
  4. Could the Fed’s policy be described as one of quantitative easing or merely one of maintaining the existing quantity of money? Explain.
  5. What are dangers in pursuing a policy of quantitative easing?
  6. What are the arguments for pursuing tight fiscal policy at the same time as loose monetary policy?
  7. Why does Thomas Hoenig claim that the Fed risks repeating past mistakes?
  8. How could the real rate of interest be reduced if the nominal rate is virtually zero and cannot be negative?
  9. Explain what is meant by ‘seigniorage’ (see the final The Economist article above).
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