Research Paper on U.S. Federal Reserve Reaction to the Global Financial Crisis of 2008/2009

The U.S Federal Reserve reacted to the global financial crisis of 2008/2009 in the following ways highlighted below.

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Provided Liquidity

The U.S Federal Reserve increased its collateral loaning to other monetary organizations to make them have access to essential finance they required for their daily activities (Wheelock, 2010). The Federal Reserve generally gives loans to those organizations that take securities like commercial banks through the discount-window process. However, the 2008/09 global financial crisis led to a widespread collapse of confidence in investment banks and other significant dealers of government securities. This made those banks and the dealers to have a challenge in securing temporary funding and was made susceptible to credit limits parallel to the bank tracks. By providing short-term secured loans to similar dealers, the Federal Reserve ensured the conditions of the financial markets were considerably improved

Supported Impaired Financial Markets

The Federal Reserve reacted to the crisis in two different ways of crucial markets that include lending temporary loans to business and the money market mutual funds (Ciro, 2016). The money market mutual funds involved collecting money from depositors and place them in short-term reserves like treasury bills as well as short-term unsecured loans identified as commercial paper. The markets from these unsecured short-term loans were the critical foundations of funding for numerous businesses. However, the collapse Lehman Brothers investment bank made the investors worry for more failures and reacted by pulling money from the commercial paper which eventually led to skyrocketing of the interest rates of the commercial paper. The Federal Reserve responded by providing secured loans to the entities of the markets to establish the availability of adequate funding. This made the interest rates on the commercial paper to fall to low levels and eventually revived the functions of these markets.

Quantitative Easing

Quantitative easing involved the Federal Reserve making new money and later use the money to purchase financial assets with longer-term maturities and inject money to the banking and economic system (Wheelock, 2010). The new money supplied increased at a steady rate before shooting up in irregular spurts during the crisis. This made the Federal Reserve specify the dollar quantity of assets that it can buy as well as reducing long term rates of interest.

European Central Bank

The European Central Bank reacted to the 2008/09 financial crisis in two different ways that included the standard and non-standard measures. The standard response of monetary policy was to modify the key interest rates in a downward manner due to the downward risk of price stability during the time of crisis. The short-term interest rates in the European region were decreased to near zero which eventually led to a favorable financial conditions in the region.

The standard monetary policy of the European region during the crisis was described as insufficient and impaired because the banking sectors in some countries were unable to perform their usual intermediation roles. The European Central Bank responded to this challenge by engaging in an arrangement of non-standard measures to reinstate an effective transmission of the impulses of monetary policy through a procedure of fixed rate tender, providing liquidity with longer maturity while expanding sets of properties that would aid as security for the receiving central bank (Bartlett & Prica, 2012). As the economic crisis continued to lock out many European countries, the Eurosystem remained eager to provide liquidity at reliable and uniform conditions over the entire region and thus helping banking institutions of the respective countries top rediscover their financial markets. Besides, to address the problem of bank funding in Europe, the Eurosystem had to directly intervene in the respective securities markets to address various malfunctioning of the separate segments.

International Monetary Fund

The international monetary fund improved its contact and reformed its lending strategies in the wake of the 2008/2009 global economic crisis. The funds had a vital role in reviving the financial markets of most developing countries to cope with the crisis and sustain their economic recovery. The IMF reversed its previous downsizing process and started to increase its lending capability significantly. The IMF improved their collaboration with other international financial bodies and standard setters to ensure the funds identify the basic macroeconomics and the response of the fiscal policy required to minimize the social and economic cost of the global financial crisis (Ciro, 2016). The entity directly assisted the members with strategies and financial advice of putting more emphasis on macro-financial linkages, financial safety nets to help in crisis awareness and management. Since the global financial crisis of 2008/09, the IMF fund has put in place useful financial tools that would prevent a sudden decrease in the trust of investors and an explosion of the liquidity crisis. The IMF lending facilities proved to be effective because it enabled the borrowers to survive the global crisis and avoid massive scale banking crisis and variable exchange rates in their financial markets.

Primary Results Achieved from the Actions of the Entities Described Above

Positive Results

One of the primary positive results achieved from the response of financial entities is the reviving of the respective financial markets by providing short term secured loans to the financial institutions of these markets. By providing secured loans to American International Group, for example, the U.S. Federal Reserve played a central role to guarantee financial instruments that would combat the financial crises. Also, by using similar policies of injecting liquidity and lowering the rates of interest down to zero, the U.S Federal Reserve and the European Central Bank significantly prevented Euro from breaking up out of the crisis of the financial crisis. The actions of the commercial entities to the 2008/09 financial crisis also helped to strengthen the national liquidity frameworks beyond the national level to enhance the mechanism that provides cross-border liquidity (Kunt et al. 2015). The response actions also helped in changing the management practices concerning liquidity as well as regulatory policies that ensure financial institutions preserved higher liquidity buffers.

Negative Results

Most of the fiscal policies introduced by these entities in the wake of the global financial crisis resulted in destructive and persistent adverse effects on growth because most of them were self-conflicting (Kunt et al. 2015). Governments were made to reduce their spending to bring their debt on levels that they can control. However, these response actions made the GDP to fall intensely with the actual effect being pushing up the proportion of debt to GDP. The result was that the countries experienced more unsustainable deficits than the previous years when the fiscal policies were not implemented. Also, the actions by the major financial entities described resulted in weak global macroeconomic outlook. This implied that borrowing had become riskier with some countries facing a greater challenge in servicing their loans because bad loans usually rise in relative to the total lending.

References

Wheelock, D. C. (2010). Lessons learned? comparing the Federal Reserve's responses to the crises of 1929-1933 and 2007-2009. Federal Reserve Bank of St. Louis Review, 92(2), 89.

Ciro, T. (2016). The global financial crisis: Triggers, responses and aftermath. Routledge.

Bartlett, W., & Prica, I. (2012). The variable impact of the global economic crisis in South East Europe.

Demirguc-Kunt, A., Martinez-Peria, M. S., & Tressel, T. (2015). The Impact of the Global Financial Crisis on Firms Capital Structure. The World Bank.