Chapter 5: Problem 28

What do you think the Federal Reserve Bank did to the reserve requirement during the \(2008-2009\) Great Recession?

Short Answer

Expert verified

During the 2008-2009 Great Recession, the Federal Reserve Bank lowered the reserve requirement, allowing banks to hold less money in reserves and freeing up more funds to lend to businesses and individuals. This action aimed to encourage borrowing and spending, stimulating economic activity and promoting recovery from the recession. Alongside this measure, the Federal Reserve also implemented other actions such as lowering the federal funds rate and establishing emergency lending programs to provide liquidity to struggling financial institutions.

Step by step solution

Understand the Federal Reserve and reserve requirement

The Federal Reserve Bank is the central bank of the United States and is responsible for managing the monetary policy and maintaining the stability of the financial system. One way it does this is through the implementation of reserve requirements. Reserve requirements are the amount of funds that a depository institution (such as a commercial bank) must hold in reserve against certain types of deposits made by customers. In effect, this means that banks are required to hold a certain percentage of their customers' deposits as cash.

Economic context of the 2008-2009 Great Recession

In order to understand the Federal Reserve's actions, it's essential to know the economic context during the 2008-2009 Great Recession. The recession began as a result of a decline in the housing market, with many people unable to pay their mortgages, leading to a wave of foreclosures. This in turn caused a financial crisis as banks and other financial institutions faced enormous losses from bad investments in mortgage-backed securities. Eventually, this crisis spread to the wider economy, affecting multiple industries and sparking a global recession.

The Federal Reserve's actions during the Great Recession

One of the Federal Reserve's primary tools for influencing the economy is adjusting the reserve requirements. By changing the reserve requirements, the Federal Reserve can directly impact the amount of money banks have available to lend. In response to the Great Recession, the Federal Reserve took several actions to stabilize the financial system and stimulate economic growth.

Lowering the reserve requirement

The Federal Reserve lowered the reserve requirement during the Great Recession. Lowering the reserve requirement allows banks to hold less money in reserves, freeing up more funds to lend to businesses and individuals. By increasing the availability of credit, the Federal Reserve aimed to encourage borrowing and spending, which would help stimulate economic activity and promote a recovery from the recession.

Other actions by the Federal Reserve during the Great Recession

In addition to lowering the reserve requirement, the Federal Reserve took other actions to help stabilize the financial system and promote economic recovery during the 2008-2009 Great Recession. These included lowering the federal funds rate (the interest rate at which banks lend to each other) and implementing various emergency lending programs to provide liquidity to struggling financial institutions. These measures were taken in conjunction with the lowering of the reserve requirement to help address the complex challenges faced by the economy during the recession.