Question

On March 15, 2020, the U.S. Federal Reserve (the Fed) decided to further support the economy....

On March 15, 2020, the U.S. Federal Reserve (the Fed) decided to further support the economy. The Fed decided on expansionary monetary policy involving change interest rates (on savings and on loans).

On March, 23, the Fed decided to purchase additional types of securities (in addition to the government securities that the Fed typically purchases when pursuing expansionary monetary policy). These additional purchases will put downward pressure on the interest rates on business loans and real estate loans (mortgages). The desired effect is to encourage more additional spending (financed by new business loans and new real estate loans) to stimulate the economy.

Given that the economy has a recessionary gap that most expect will get larger in the coming months, choose one of the two views below to support. Keep in mind that the money to pay for this expansionary monetary policy involving the purchase of government and other securities, is created (or “printed”) by the Fed. Unlike fiscal policy, the Fed does not need to borrow to pay for its purchases (and then raise taxes in the future to pay back the borrowed funds).

(Note that the securities the Fed usually purchases “IOUs.” These IOUs are typically bonds that entitle the owner of the bond to receive future interest payments and the entire principal amount on the bond. So the Fed, as the owner of the IOU, can be paid back these amounts in the future for each IOU purchased).

Select from two of the views below.  Support your choice by including at least one reason to support your team’s choice. Use FRISCO to help you develop your view and reason(s).

View A: We support the Fed’s recent expansionary monetary policy actions to close the current recessionary gap.

View B: We do not support the Fed’s recent expansionary monetary policy actions to close the current recessionary gap.

Homework Answers

Answer #1

View A:

Monetary policy is a policy determined by central bank and has two tools; interest rates and money supply. When there is recession and central bank wants to boost economic activity then it decreases interest rates and increases money supply. This is called as expansionary monetary policy.

Expansionary policies create more aggregate demand, decrease unemployment. It can be inflationary if all resources are fully used and there is no spare capacity In the short term common people and investors are expected to spend less but as people get confidence of future earnings they along with investors will spend more long run potential can be achieved. iIt is important to generate demand now as long term impacts will be heavy on government borrowings also and will create more. fiscal deficit.

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