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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鈥檚 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

Many developing countries suffer from endemic corruption. How does this help explain why these countries鈥� economies typically have high inflation and economic stagnation? Use a graph of aggregate demand and supply to demonstrate.

It can be an interesting exercise to compare the purchasing power of the dollar over different periods in history. Go to https://www.bls.gov/data/inflation_ calculator.htm to find the inflation calculator. Use this calculator to answer the following questions. a. If a new home cost \(125,000 in 2017, what would it have cost in 1950? b. The average annual household income in 2017 was about \)50,000. What would this income have been in 1945? c. An average new car cost about $25,000 in 2017. What would this car have cost in 1945?

d. Using your results from parts (b) and (c), did the purchase of a new car consume more or less of an average household鈥檚 income in 2017 than in 1945?

Use a graph of aggregate demand and supply to demonstrate how lags in the policy process can result in undesirable fluctuations in output and inflation.

In what way is a permanent negative supply shock worse than a temporary negative supply shock?

Why does the self-correcting mechanism stop working when the policy rate hits the zero lower bound?
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