The Fed and the Economy

The Fed and the Economy

"The financial crisis of 2007-09 is widely viewed as the worst financial disruption since the Great Depression of 1929-33." (6, p. 89) In 2006 we saw lots of growth in the housing market. Big investors liked the idea of investing in pools of mortgages, but after everyone who qualified for a mortgage had one, banks began lending to people not so capable of paying a home, these were sub-prime mortgages. This led to many homeowners defaulting on their mortgages. Now instead of rising prices on homes it all began to plump. The value of homes was way below the value of mortgages. It made no sense having high monthly payments for a home that was not worth much. Central banks were not prepared for such downturns; the Federal Reserve had to take action before the situation worsened. The recession did not turn to be a short term fall of the economy; things in fact got hectic and it is where we see what the Federal Reserve has done to try to get the economy back to a steady growth.

In the October FOMC meeting it was announced that the housing sector was not flowing so good and the unemployment rate was rising as well. The fall of the housing prices cut home building and purchases. This caused many mortgage foreclosures while nation's leading banks lost billions of dollars. It was also stated that the credit of most households remained strong but not so good for those on subprime mortgages. There was a projection made as well pertaining to the unemployment rate. The Fed's projection for the year 2009 was an unemployment rate of about 4.6 to 5.0. In December employment kept slowing down, mostly due to the weakness in the housing market. There were gradual declines of employment in residential construction, as well as in factories and the real estate sector. According to the U.S. Bureau of Labor and Statistics the unemployment rate today is 9.7%. It has been the same rate since the beginning of 2010. The Fed's intentions in October of 2007 were to target the federal funds rate to 4 ¾%. With this they wanted to keep the economy growing, at a slower rate because the tightening of credit has much affected the housing market. Spending also began to go down in the last months of 2007. At this point the Federal Reserve knew things were not doing so good and had to start implementing policies that would smooth out these economic bumps.

Ending the 2007 with declining economic activity, the Fed began applying monetary policy tools to promote expansion in the economy. In December of 2007 their target for the federal funds rate was now 4 ½%. Their actions wanted to prevent some of the unfavorable effects that could arise. Lowering short-term policy rates like the discount rate and federal funds rate was what the Fed was using at the start of 2008. By March of 2008, the Fed was implementing a stricter federal funds rate. Their target rate was now down to 3% and the discount rate to 3 ½%. But not conformed to the outlook of the nation's instability, the committee also announced that it was seeking an even lower FFR of around a 2 ¼%. To get these rates to where they are targeted at, the Fed began to purchase treasury securities to increase money reserve balances. What it wants here is to have more money in circulation, more liquidity for banks to have excess money and boost up lending to consumers. To be more specific, the