One of the actions which Federal Reserve has taken to combat the recession was to ease
monetary policy. Federal Open Market Committee continually decreased its target federal
funds rate until target rate was set at a range from 0 to 0.25%. This action was consistent with
the objective of having high and sustainable growth in the economy, as lower interest rates
stimulate various kinds of spending and increase aggregate demand. A drop in interest rates
will result in a lower exchange value of the dollar, because US-based assets would become less
attractive for investors and, consequently, demand for dollar would fall. This in turn will boost
U.S. exports by lowering the cost of U.S. goods and services in foreign markets and make
imported goods more expensive, which will encourage businesses and households to purchase
domestic goods instead. Lower interest rates would also make investment projects that were
only marginally profitable for companies more attractive with lower financing costs, leading to
an increase in business activity and job creation. Also, lower consumer loan rates will elicit
greater demand for consumer goods, such as cars and other relatively high priced goods. Lower
mortgage rates will make housing more affordable and lead to more home purchases. They will
also encourage mortgage refinancing, which will reduce ongoing housing costs and enable
households to purchase other goods.
Another action of Federal Reserve was associated with its function as the lender of last
resort. The Federal Reserve provided large quantity of funds through its discount window to
corporations which Federal Reserve deemed solvent. Federal Reserve also made significant
capital injections into banking system by introducing projects such as Term Auction Facility
(TAF) and Term Securities Lending Facility (TSLF). These facilities provided financial institutions
with loans collateralized by Mortgage backed securities and other types of assets.
Through these steps Federal Reserve ensured that sound financial institutions will be able to
address their short term liquidity issues. In the process of doing so, however, the Fed
dramatically increased the quantity of money in the system. Fed’s balance sheet went from
around 869 billion in August 2007 to almost 2.3 trillion by the end of 2008. With so much
money in supply, there are significant concerns about keeping inflation at low and stable levels,
which is one of the primary objectives of the Federal Reserve.
Monetary policy and the economy. http://www.federalreserve.gov/pf/pdf/pf_2.pdf
Timeline of financial crisis. http://timeline.stlouisfed.org/index.cfm?p=timeline
Credit and liquidity programs and balance sheet.