This leads to a second way in which quantitative easing differs from traditional monetary policy. Instead of buying government bonds, the Fed also started buying private mortgage-backed securities, something it had never done before. During the financial crisis that triggered the recession, mortgage-backed securities were called “toxic assets” because when the housing market collapsed, no one knew what those securities were worth, putting the financial institutions that held those securities on very fragile ground. With its offer to buy mortgage-backed securities, the Fed has lowered both long-term interest rates and potential “toxic assets” on the balance sheets of private financial corporations, which would strengthen the financial system. The most powerful and widely used of the three traditional instruments of monetary policy – open market operations – works by increasing or reducing the money supply in a way that affects the interest rate. By the end of 2008, when the U.S. economy was in the throes of a recession, the Federal Reserve had already cut the interest rate to near zero. With the recession still ongoing, the Fed has decided to pursue innovative, non-traditional policies known as quantitative easing (QE). This is the purchase by central banks of long-term securities secured by public and private mortgages to provide credit and stimulate aggregate demand. In addition to monetary policy, fiscal policy is an economic instrument. A government can increase its borrowing and spending to stimulate economic growth. Monetary and fiscal instruments have been used generously in a number of government and Federal Reserve programs launched in response to the COVID-19 pandemic. Figure 4 shows how the Federal Reserve has conducted monetary policy in recent decades by targeting the key federal funds interest rate.
The chart shows the interest rate on federal funds (remember that this interest rate is set by open market operations), the unemployment rate, and the inflation rate since 1975. Various episodes of monetary policy during this period are presented in the chart. For the period from the mid-1970s to the end of 2007, the Federal Reserve`s monetary policy can be broadly summarized by examining how it aligned the key interest rate using open market operations. UPSC CSE 2020) If the RBI decides to pursue an expansionary monetary policy, which of the following measures would it not do? The quantitative easing policies of the Federal Reserve (and other central banks around the world) are generally considered temporary emergency measures. If these measures are indeed to be temporary, the Federal Reserve must stop issuing these additional loans and selling the accumulated financial securities. The concern is that the process of quantitative easing may prove more difficult than it was to implement. Evidence suggests that QE1 had some success, but QE2 and QE3 were less successful. Although the initial effect of contraction policies is to reduce nominal gross domestic product (GDP), which is defined as gross domestic product (GDP) valued at current market prices, this often ultimately leads to sustainable economic growth and smoother business cycles. Monetary policy affects interest rates and the amount of solvent assets available, which in turn affects several components of aggregate demand. A restrictive or restrictive monetary policy, which leads to higher interest rates and a decrease in the number of solvent assets, will reduce two components of aggregate demand. Business investment will decline because it is less attractive for companies to borrow money, and even companies that have money will find that at higher interest rates, it is relatively more attractive to invest these funds in an investment than to invest in physical capital. In addition, higher interest rates will discourage consumers from borrowing for large items such as homes and cars.
Conversely, a loose or expansionary monetary policy that leads to lower interest rates and an increase in the amount of solvent funds will tend to increase business investment and consumer borrowing for large items. A concrete example of a policy of contraction at work can only be found in 2018. As reported by the Dhaka Tribune, the Bangladesh Bank has announced its intention to issue a contractionary monetary policy to control the supply of credit and inflation and, ultimately, maintain economic stability in the country. When the economic situation changed in the following years, the Bank switched to an expansionary monetary policy. So how can a central bank “raise” interest rates? When describing a central bank`s monetary policy measures, it is common to hear that the central bank has “raised interest rates” or “lowered interest rates.” We need to be clear about this: specifically, through open market operations, the central bank changes bank reserves in a way that affects the supply curve of solvent assets. As a result, interest rates change, as shown in Figure 1. If they don`t meet the Fed`s target, the Fed can provide more or less reserves until interest rates do. In general, contractionary monetary policy and expansionary monetary policy involve changing the amount of money in a country. Expansionary monetary policy is simply a policy that expands (increases) the money supply, while contractionary monetary policy reduces (decreases) a country`s money supply. Restrictive monetary policy is driven by increases in the various policy rates controlled by modern central banks, or by other means that lead to the growth of the money supply. The goal is to reduce inflation by limiting the amount of active money circulating in the economy.
It also aims to suppress unsustainable speculation and capital investment that may have triggered previous expansionary measures. Monetary policy is a set of tools available to a country`s central bank to promote sustainable economic growth by controlling the overall supply of money available to banks, consumers and businesses in the country. In the context of expansionary policies, the monetary authority often lowers interest rates to encourage the spending of money and make savings unattractive. Consider Episode 1 in the late 1970s. .