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Episode 3

However, in Episode 3 in the late 1980s, inflation appeared to be creeping up again, rising from 2% in 1986 up toward 5% by 1989. In response, the Federal Reserve used contractionary monetary policy to raise the federal funds rates from 6.6% in 1987 to 9.2% in 1989. The tighter monetary policy stopped inflation, which fell from above 5% in 1990 to under 3% in 1992, but it also helped to cause the recession of 1990–1991, and the unemployment rate rose from 5.3% in 1989 to 7.5% by 1992.

Episode 4

In Episode 4, in the early 1990s, when the Federal Reserve was confident that inflation was back under control, it reduced interest rates, with the federal funds interest rate falling from 8.1% in 1990 to 3.5% in 1992. As the economy expanded, the unemployment rate declined from 7.5% in 1992 to less than 5% by 1997.

Episodes 5 and 6

In Episodes 5 and 6, the Federal Reserve perceived a risk of inflation and raised the federal funds rate from 3% to 5.8% from 1993 to 1995. Inflation did not rise, and the period of economic growth during the 1990s continued. Then in 1999 and 2000, the Fed was concerned that inflation seemed to be creeping up so it raised the federal funds interest rate from 4.6% in December 1998 to 6.5% in June 2000. By early 2001, inflation was declining again, but a recession occurred in 2001. Between 2000 and 2002, the unemployment rate rose from 4.0% to 5.8%.

Episodes 7 and 8

In Episodes 7 and 8, the Federal Reserve conducted a loose monetary policy and slashed the federal funds rate from 6.2% in 2000 to just 1.7% in 2002, and then again to 1% in 2003. They actually did this because of fear of Japan-style deflation; this persuaded them to lower the Fed funds further than they otherwise would have. The recession ended, but, unemployment rates were slow to decline in the early 2000s. Finally, in 2004, the unemployment rate declined and the Federal Reserve began to raise the federal funds rate until it reached 5% by 2007.

Episode 9

In Episode 9, as the Great Recession took hold in 2008, the Federal Reserve was quick to slash interest rates, taking them down to 2% in 2008 and to nearly 0% in 2009. When the Fed had taken interest rates down to near-zero by December 2008, the economy was still deep in recession. Open market operations could not make the interest rate turn negative. The Federal Reserve had to think “outside the box.”

Quantitative easing

The most powerful and commonly used of the three traditional tools of monetary policy—open market operations—works by expanding or contracting the money supply in a way that influences the interest rate. In late 2008, as the U.S. economy struggled with recession, the Federal Reserve had already reduced the interest rate to near-zero. With the recession still ongoing, the Fed decided to adopt an innovative and nontraditional policy known as quantitative easing (QE)    . This is the purchase of long-term government and private mortgage-backed securities by central banks to make credit available so as to stimulate aggregate demand .

Quantitative easing differed from traditional monetary policy in several key ways. First, it involved the Fed purchasing long term Treasury bonds , rather than short term Treasury bills . In 2008, however, it was impossible to stimulate the economy any further by lowering short term rates because they were already as low as they could get. (Read the closing Bring it Home feature for more on this.) Therefore, Bernanke sought to lower long-term rates utilizing quantitative easing.

This leads to a second way QE is different from traditional monetary policy. Instead of purchasing Treasury securities, the Fed also began purchasing private mortgage-backed securities, something it had never done before. During the financial crisis, which precipitated the recession, mortgage-backed securities were termed “toxic assets,” because when the housing market collapsed, no one knew what these securities were worth, which put the financial institutions which were holding those securities on very shaky ground. By offering to purchase mortgage-backed securities, the Fed was both pushing long term interest rates down and also removing possibly “toxic assets” from the balance sheets of private financial firms, which would strengthen the financial system.

Quantitative easing (QE) occurred in three episodes:

  1. During QE 1 , which began in November 2008, the Fed purchased $600 billion in mortgage-backed securities from government enterprises Fannie Mae and Freddie Mac.
  2. In November 2010, the Fed began QE 2 , in which it purchased $600 billion in U.S. Treasury bonds.
  3. QE 3 , began in September 2012 when the Fed commenced purchasing $40 billion of additional mortgage-backed securities per month. This amount was increased in December 2012 to $85 billion per month. The Fed stated that, when economic conditions permit, it will begin tapering (or reducing the monthly purchases). By October 2014, the Fed had announced the final $15 billion purchase of bonds, ending Quantitative Easing.

The quantitative easing policies adopted by the Federal Reserve (and by other central banks around the world) are usually thought of as temporary emergency measures. If these steps are, indeed, to be temporary, then the Federal Reserve will need to stop making these additional loans and sell off the financial securities it has accumulated. The concern is that the process of quantitative easing may prove more difficult to reverse than it was to enact. The evidence suggests that QE 1 was somewhat successful, but that QE 2 and QE 3 have been less so.

Key concepts and summary

An expansionary (or loose) monetary policy raises the quantity of money and credit above what it otherwise would have been and reduces interest rates, boosting aggregate demand, and thus countering recession. A contractionary monetary policy, also called a tight monetary policy, reduces the quantity of money and credit below what it otherwise would have been and raises interest rates, seeking to hold down inflation. During the 2008–2009 recession, central banks around the world also used quantitative easing to expand the supply of credit.

Questions & Answers

what is microeconomics and macroeconomics
Usman Reply
microeconomic deal with the study of individual firms and household and macroeconomics deal with the economy as a whole.
definition of Monopoly
malonzy Reply
Wat is the importance of economics
Vicky Reply
it broaden one's mind
it help us to make good choices
what is an efficient wage and how it causes structural unemployment and how it could be shown graphically?
Amos Reply
economics is a social science and an art discuss
Kerry Reply
further explanation on the definition
Samuel Reply
is demand the same as quantity demanded
what is business economics
Nelson Reply
business economics is the way the society uses its limited resources to satisfy their unlimited wants
what is business economics
how did Mc connel defined economics
Isaac Reply
what is a economy planning?
Jacob Reply
what is demand
Sunday Reply
demand means desire for a commodity backed by willingness & ability to pay for that commodity
what is supply
supply means suppliers supplying more commodities when price's high or less when price's low to satisfy human want
the coefficient of price elasticity of supply is the measure of percentage change in the quantity supplied of a good due to a given percentage change in its price.
Please what is Economics of Scales?
what is cardinal and ordinal utility?
Cardinal utility is the satisfaction derived by the consumers from the consumption of goods and services while ordinal is ranked in terms of preference.
Please explain what is meant by Economic Integration?
Please I need help!!!!
economics scales I don't know but I know laws of returns to scale
can someone help explain to me what is fairly inelastic dd
Economics Economics - The study of how people use their limited resources to try to satisfy unlimited wants
Economic integration has been one of the main economic developments affecting international trade in the last years. Countries have wanted to engage in economic cooperation to use their respective resources more effectively and to provide large markets for member-countries of the resulting integrate
Inelastic Demand When consumers are relatively unresponsive to price changes. A PED coefficient of less than one means that a particular change in the price of a good will be met by a proportionally smaller change in the quantity demanded.
demand refers to goods and services that a consumer is willing and able to buy at given rate over a given period of time
Demand  - The entire relationship between the quantity of product that buyers wish to purchase per period time and the price of that product..
what are the factor that affect demand
what is development planning?
Emmanuel Reply
What is economics?
Shubham Reply
economics is study of scarcity and how humans make decisions.
reason for development planning in West Africa
what is development planning?
What is homo Economicus?
nongo Reply
when a person is part 50% rational and the other part of him is 50% focused on money as an incentive
what makes the economy to be stable
what measures are necessary to the economy which is not doing fine
must find out the problems originating from and take remedy for it.
Economics as a social science Discuss

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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