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Chapter 24: Q. 4 (page 655)

During the global financial crisis, how was the Fed able to help offset the sharp increase in financial frictions without the option of lowering interest rates further? Did the Fed’s plan work?

Short Answer

Expert verified

he Fed dropped the fed funds rate to zero to offset or mitigate the effects of the global financial crisis by increasing aggregate demand in the economy.

The Fed's actions were insufficient and unable to properly stabilise the economy's economic activity.

Step by step solution

01

Step 1. Introduction

Financial crises occur when a money-related resource loses a significant portion of its nominal value all of a sudden.

02

Step 2. Explanation

The Fed dropped the fed funds rate to zero to offset or mitigate the effects of the global financial crisis by increasing aggregate demand in the economy. However, this approach proved insufficient to keep the economy's aggregate demand stable. As a result, the Fed turned to unconventional monetary policy and began purchasing assets, which helped to lower medium and long-term interest rates while also increasing aggregate demand. Because the severity of the crisis was so great, the Fed's actions were insufficient and unable to properly stabilise the economy's economic activity.

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Most popular questions from this chapter

The fact that it takes a long time for firms to get new plants and equipment up and running is an illustration of what policy problem?

How can demand-pull inflation lead to cost-push inflation?

As monetary policymakers become more concerned with inflation stabilization, the slope of the aggregate demand curve becomes flatter. How does the resulting change in the slope of the aggregate demand curve help stabilize inflation when the economy is hit with a temporary negative supply shock? How does this affect output? Use a graph of aggregate demand and supply to demonstrate.

Because government policymakers do not consider inflation desirable, their policies cannot be the source of inflation.” Is this statement true, false, or uncertain? Explain your answer.

The Problems update with real-time data in MyLab Economics and are available for practice or instructor assignment. 1. On January 19, 2017, the Federal Reserve released its amended statement on longer-run goals and monetary policy strategy. It stated: “The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate” and that “the median of FOMC participants’ estimates of the longer-run normal rate of unemployment was 4.8 percent.” Assume this statement implies that the natural rate of unemployment is believed to be 4.8%. Go to the St. Louis Federal Reserve FRED database, and find data on the personal consumption expenditure price index (PCECTPI), the unemployment rate (UNRATE), real GDP (GDPC1), and real potential gross domestic product (GDPPOT), an estimate of potential GDP. For the price index, adjust the units setting to “Percent Change From Year Ago.” Download the data into a spreadsheet.

  1. For the most recent four quarters of data available, calculate the average inflation gap using the 2% target referenced by the Fed. Calculate this value as the average of the inflation gaps over the four quarters.
  2. For the most recent four quarters of data available, calculate the average output gap using the GDP measure and the potential GDP estimate. Calculate the gap as the percentage deviation of output from the potential level of output. Calculate the average value over the most recent four quarters of data available.
  3. For the most recent 12 months of data available, calculate the average unemployment gap, using 5.6% as the presumed natural rate of unemployment. Based on your answers to parts (a) through (c), does the divine coincidence apply to the current economic situation? Why or why not? What does your answer imply about the sources of shocks that have impacted the current economy? Briefly explain.
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