1) On the beginning of the speech, she mentioned that FOMC faces two key challenges. one is the quest for maximum employment and price stability in Congress. If the main tool of our regular policy is reduced to essentially zero, it will weak the US economy. The first challenge is led to the second one, which is how to ensure that we can reduce the monetary policy in an orderly manner when it is no longer needed. If we cannot do it the ability to promote maximum employment and price stability will be reduced.
And then, she mentioned how they solve the problems. According to the first challenge, they use monetary policy regulation to strengthening long-term interest rate guidance and large-scale asset purchases. In order to face the great recession, Fed is going to remove the policy.
what is more, she mentioned two unconventional monetary policy tools to face the great recession. There is forward-looking guidance on large-scale asset purchases and intentions toward future short-term interest rates. And FOMC is working on lowering long-term interest rates is to help the U.S. economy recover from the recession and curb deflationary pressures.
According to face future crisis like great recession, FOMC will use the impact of short-term interest rates on the federal funds rate as the primary tool.
Overall, because of the great recession, Fed face two main challenges, which is FOMC had to provide additional policy controls after its short-term interest rates had reached their effective lower limit and FOMC had to reduce the accommodation while expanding the federal reserve balance sheet.
A) Frist, 1 pound= 1.68 dollar
Investment amount on 7/15= 100 million dollars= 100/1.68=59.52 million pounds
The interest rate on 1 year CD on pound is 0.02
1 year later the exchange rate is 1.55 per US/ pound
Investment amount after 1 year= (1+ 0.02) *59.52=60.71 million pounds *1.55= 94.10 million dollars
loss= 94.10millon- 100 million= -5.9 million dollars
rate of return= -5.9/100=-5.9%
Therefore, have a negative return of 5.9% on the investment
B) If CFO invest in the US CD, the amount after 1 year will be 100*0.5%=100.5 million dollars, because of the question A will know that the amount after 1 year UK CD is 60.71 million pounds. Thus, in order to make profit, the expected exchange rate of pound should be greater than 100.6/60.71=1.65 USD per pound
3) Between February 2008 and Summer 2009, the Fed supplemented its open market operations with a greatly expanded program of direct lending (both overnight and short term 28 and 84 day loans) to commercial banks, investment banks, brokerage and primary dealer units of bank holding companies. It also agreed to accept a wider range of short-term securities (instead of accepting only T-Bills) as collateral on these loans and even initiated a program to buy commercial paper from money market funds. Explain why the Fed created all these extraordinary direct lending facilities instead of simply relying on traditional open market purchases of Treasury securities. 4 pts
It is because the Fed faced the great recession in 2008 and 2009. Due to the great recession, the traditional monetary policy tools didn’t work so well, Fed have to use an aggressive monetary policy and this situation is called a liquidity trap.
Central bank is the one who control the open market operations. They use the open market to influence the money supply in the economy. Usually, the central bank buys or sells government bonds to affect short-term interest rate in the economy. However, liquidity trap is the one who injected cash into private banking system, so central bank cannot reduce the interest rate to make the monetary policy loss efficacy. In liquidity traps, consumers will avoid bonds and save money because it is widely assumed that interest rates will rise quickly. This helps to reduce interest rates uniformly across asset groups, thereby freeing borrower’s higher interest rate burden and creating new demand.
A) Based on the information above, when can imaging that after the recession, the level of confidence of lenders and borrowers started to return to normal levels and the level of investment rose sharply which causes the economy to increase its money supply too fast and the dollar demand has increased. As a result, the dollar value has risen. The Fed’s three QE have increased the money supply. Due to huge investment, the size of the Fed’s long-term US Treasury bonds and mortgage-backed bonds has increased, and the Fed’s portfolio has increased substantially. The problems faces are that the economy is rising inflation, bank deposits and deposits increasing.
One of the tool to help solving this problem is raising the cash reserve ratio and the statutory liquidity ratio. It will reduce the ratio of excess reserves to commercial banks. When the bank borrows less cash, the money supply will decrease.
Although the Fed must consider the effect on the inflation rate, unemployment rate and so on in order to take appropriate action, in this case the main consider perspective should be the currency value. Because the dollar exchange rate is mainly determined by changes in the foreign exchange market D and S, the Fed usually do not want to manipulate the exchange rate under normal economic conditions. If domestic currency rate goes up, it helps the economy as well as causes some trouble. For example, if US $ becomes stronger than other currencies and pays in your home currency, you should pay a higher amount. This can lead to increased product costs and to inflation. And there is a condition in the question mentioned that the value of dollar is increasing against Euro, RMB and Yan. Therefore, the only currency that dominates international trade is the United States dollar. As a result, the global market will see increased demand for the U.S. dollar. Therefore, maintaining the present value of the U.S. dollar is good for the U.S. economy.
In P0, it reaches the full employment, when the dollar rise, AD will decrease as graph shows, AD will shift to the left.
When comparing interest rates, usually long deposit rates will be higher due. And the LT interest rate is risker than the ST. In this question, both bonds are zero coupon bond, and the 1 year US treasury securities is 0.28% and the 2- year one is 0.69%, thus the expectation of 1 year yield is
Thus, the data suggest the interest rate at one year later should be higher.
A) A long-term state of the US is that budget deficit= G-T>0 which means that G is higher than tax every year. In the question, there is a condition that budget deficit is almost $19 trillion, but it is good for the economy growth. One of the argument could be G is too high, so the AD has increase, but not so much tax revenue leading to budget cannot balance. From my perspective, we can increase the tax payment for high-income people in order to reduce the deficit.
B) No, it is not. When the budget deficit high, the inflation rate will be higher and the economy will be unstable. And both of them are use their way to reduce the deficit. In the other perspective, the deficit can help the economy growth.