Financial Crisis 2008/9 Essay Example

Introduction

The Federal Reserve System serves as the American central bank. It is considered as the most influential financial institution to the American and global economy. Therefore, the Federal Reserve has the ability to control the money supply in the United States and around the world. The Federal Reserve System consists of three components. Firstly, the Board of Governors who usually stipulate the monetary policy. It has seven members who determine the reserve's conditions and discount rates for the affiliated banks. Secondly, the staff economists that are liable for the provision of all the required analyses such as the bi-annual Monetary Report to the Congress and periodic Beige Book Reports. Finally, the Federal Open Market Committee that usually supervises the open market processes through establishing the federal funds rate. The Federal Open Market Committee consists of four bank presidential representatives and board members. It meets roughly eight times annually. Additionally, the Federal Reserve Banks implements policies and oversees the operations of commercial banks. The Federal Board and Federal Reserve Bank's partnership helps in supervising the commercial banks.

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Federal Reserve and the 2008/9 Financial Crisis

The Federal Reserve System has the mandate to address any financial crisis that the American economy is exposed to, based on its fundamental role in policymaking. Therefore, in 2008 and 2009 the Federal Reserve System's key objective was to mitigate the interconnected crises facing the American economy especially the banking sector. The Federal Reserve deployed the traditional monetary policy and other unconventional strategies in an attempt to resolve the economic recession. As a result, the Federal Reserve adopted a reduction in the interest rate to offer financial assistance to the crumbling financial institutions. The quantitative easing and forward guidance were some of the key policies the Federal Reserve endorsed (Taylor and Williams 59). Besides, during the 2008/9 recession period, the unemployment rate remained significantly high regardless of the Federal Reserve's efforts to mitigate the crisis. Consequently, the political critics accused the American central bank of excessive activism and complacency. Hence, the Federal Reserve's reliance on unconventional measures to attenuate the crisis led to it being subjected to unprecedented political criticism.

The reduction in the interest rate was one of the main traditional monetary measures the Federal Reserve used to respond to the high unemployment rate in the 2008/9 financial crisis. For that reason, the Federal Reserve anticipated boosting the national economy by reducing the interest rates that influenced the loan repayment initiatives among the financial institutions (Stroebe and Taylor 7). Hence, the cuts in the interest rates from the federal funds were expected to result in low-interest rates to the economy. The low rates were meant to persuade stakeholders to invest in new business ventures, boost the consumers' purchasing power in real estate, and increase the essential goods sales. Therefore, the Federal Reverse based its interest rate reduction on the assumption that the supplementary expenditure would increase its economic output and employment opportunities in the depressed national economy.

When the economy is not in a crisis increased spending causes an inflation. In case, the inflation rate worsens the Federal Reserve has to raise its fund rate. Consequently, the increased federal funds rate causes a significant increase in interest rates and reduced spending among buyers. Likewise, the Federal Reserve began reducing its interest rates from September 2007 to June 2008. The high prices on the agricultural products and energy led to the reduced interest rates being terminated to prevent a probable inflation risk to the deteriorated economy. For example, after the Federal Board's consecutive meetings and the Lehman Brothers bankruptcy the Federal Reserve endorsed a constant 2% policy rate. Nevertheless, the economy deteriorated swiftly and by December 2008 the interest rates were almost 0% and could not be lowered further (Taylor and Williams 61). Therefore, the traditional monetary policy adopted by the Federal Reserve worsen the recession rather than mitigating it.

Main Economic Goals

The Federal Reserve's main objective is to establish a resilient economy within the American jurisdiction. Hence, Congress expects the Federal Reserve to design a monetary policy that guarantees moderate interest rates, stable prices, and sustainable employment. The Federal Reserve's approach to reducing the interest rates destabilized the prices of the agricultural and petroleum products increase the likelihood of the economy experiencing an inflation (Taylor and Williams 68). The reduced interest rates interfered with the prices' stability leading to the investors and consumers being worried about the rise in the market prices when making long-term financial decisions. The Federal Reserve's anxiety to attain favorable interest rates through the reduced interest rates approach worsen the economic crisis impact on price stability and sustainable employment. As a result, the traditional monetary policy adopted by the Federal Reserve during the 2008/9 crisis amplified the unemployment, price instability, and inflation rates.

Historic Monetary and Fiscal Policy

The 2008/9 recession was the worst economic crisis since 1930 that posed challenges to the policymakers and economy. The Federal Reserve and the American government chose to respond to the economic meltdown using the non-traditional and traditional measures (Bordo 106). The measures implemented had been customized suit the 2008/9 economic recession circumstances. Therefore, the Federal Reserve adopted the bailout policy, forward guidance and quantitative easing measures to enhance the price stability and sustainable development.

The Federal Reserve offered backup liquidity to depository institutions. Similarly, the government and Federal Reserve had to support the financial markets by providing liquidity to the non-bank financial firms. The Federal Reserve was forced to innovate and adapt to dynamic measures to attain liquidity provision and monetary policy criteria required to handle the crisis. For instance, the short-term policy on lowering rates only could not counter the adverse impact on the financial system and economy American adequately. The government and the Federal Reserve incorporated agency and Treasury securities as it most appropriate liquidity to boost the daily operations of most banking systems (Goodfriend 9). The agency and treasuries securities altered the cumulative amount of the reserve balances all banks owed at the Federal Reserve. Consequently, the interbank funding markets had the responsibility of distributing liquidity among the American financial bodies and globally. Additionally, the Federal Reserve utilized the discount window strategy to offer loans to depository institutions and commercial banks. The discount window empowered banks to be issued overnight loans at a reasonable market rate whenever they required an impromptu short-term funding. However, the discount window catered for short-term liquidity shortages arising from their operational problems rather than the fundamental funding issues.

The bailout strategy was one of the grave errors the U.S government and Federal Reserve made during the 2008/9 crisis. The bailouts from the government and Federal Reserve strived to assist companies that were on the verge of being bankrupt such as American International Group, government-sponsored enterprises, and Bear Stearns. The moral implications of bailing such firms encouraged other investment banks to follow such risky strategies based on the assumption the government would intervene. Such policy led to the financial system being more fragile. When the Federal Reserve opted to let the Lehman Brothers be bankrupt the banking stakeholders were shocked and their fear on their businesses' vulnerability during the recession increased. According to Bordo, the monetary authorities' negligence on the Lehman Brothers depicted an example on when the Federal Reserve and government bent their policies to rescue insolvent banks (122). The failure of such financial institutions could have caused panic among the clients and investors. Therefore, the allegations from the Federal Reserve's chairperson that it was legally incapable of preventing the Lehman Brothers' bankruptcy provided a justification for its catastrophic decision on the Lehman incident.

Quantitative easing strategy was intentionally delayed by the Federal Reserve's indecisiveness on reducing the interest rate on the federal funds and excess reserves rates to roughly 0%. The policy was based a fallacy that reducing the interest rates to 0% would damage the mutual fund associated with the money market. Besides, quantitative easing discouraged most of the financial organizations from lending (Kudlyak and Sanchez 15). Therefore, the Large-Scale Asset Purchases measures were based on an option rather than specific rule-like evaluations. For instance, the forward guidance strategy that supplemented the quantitative easing policy lacked the rule-like behavior too. The policy did not confine to its intended purpose to streamline the bond purchases before its exit from the quantitative easing policy. Such short-term measures for the Federal Reserve led to policy uncertainty that threatened the financial institutions' investment and lending.

Current Volatile Environment

Most of the critics to the Federal Reserve's conduct during the 2008/9 recession claimed that the fiat currency idea was a bad idea. For example, Ron Paul, a former Republican's presidential candidate, alleged that the Americans should disintegrate the Federal Reserve and return the U.S to its gold standard economy. Similarly, Paul Ryan, a Republican, claimed that the United States dollar should be engraved with various commodities instead of specific metals, for instance, gold (Stroebe and Taylor 29). Furthermore, the public's criticism of the Federal Reserve's approach during the recession was sharply divided into two key points. Some people purported that the Federal Reserve's unconventional monetary strategies were extremely inflationary while other critics argued that the Federal Reserve's actions were justified. The inflation criticism has been supported by most politicians in the Congress who intend to modify the Federal Reserves' mandate to focus only the price stability concerns instead of the dual obligations on unemployment and inflation. Nonetheless, given the relatively low inflation rates in the past three years, the basis of this agreement is quite challenging to comprehend. Conversely, the Federal Reserve's proponents acknowledged that handling the high unemployment and low inflation rates violated the Federal Reserve's mandate (Goodfriend 11). Hence, they suggest that the government and Federal Reserve should endorse aggressive policies that stimulate the gross domestic product growth.

A majority of financial scholars and economists argue that the Bernanke-era Federal Reserve handled the economic recession issue successfully. The 2008/9 crisis on the global economy almost replicated the Great Depression but the Federal Reserve avoided the occurrence of a cataclysmic situation (Bordo 113). Most of the critics supporting this view claim that the Federal Reserve was very active during the crisis period than even before when it was addressing the high unemployment and slow economic growth issues. Hence, the United States economy has been exceptional compared to other developed nations that experienced a similar economic recession.

Balance Sheet Policy

The Federal Open Market Committee has upheld its reinvesting d...