Such developments have a long lasting impact on the overall economy, as well as on specific industry sector or market. Monetary policy is different from fiscal policy as the former relates to borrowing, consumption and spending by individuals and private businesses, while the latter refers to taxes, government borrowing and spending. Types of Monetary Policies At a broader level, monetary policies are categorized as expansionary or contractionary. If a country is facing a high unemployment rate during a slowdown or a recessionthe monetary authority can opt for expansionary policy which is aimed at bumping up the economic growth and expanding the overall economic activity in the region.
What accounts for the subprime financial turmoil which burst onto the scene in the summer of ? Who is most to blame for this mess? A number of interrelated factors can be pointed to in accounting for the subprime mortgage crisis and resulting credit crunch that exploded in the summer of Overly loose monetary policy, poor regulation of financial markets, the overexpansion of the subprime mortgage market and accompanying housing bubble, and the rapid growth of complex financial derivatives based on pooled mortgage loans all played significant roles in bringing about the crisis.
The Fed justified its actions by pointing out that relatively low inflation during the period leading up to the crisis, as measured by the Consumer Price Index CPIled them to see no need to raise interest rates and stifle the economic recovery underway.
While it is clear that monetary policy errors played a foundational role in creating the economic environment that enabled and accelerated the housing bubble, the greatest responsibility for the catastrophic extent of the crisis rests with the managers of mortgage lenders and financial institutions.
Irresponsible lending practices, unrealistic expectations about future home values, the euphoria over high returns from mortgage backed securities CDOsalong with the inaccurate pricing of risk, are some of the primary reasons that so many investors and financial institutions worldwide were overly exposed to the risks inherent in the subprime mortgage market.
Prior to the default rate on subprime loans, though higher than that of prime and near prime loans, were not so high as to lead investors to believe that CDOs were riskier than their high credit ratings indicated. It seems that investors, financial institutions, and ratings agencies failed to realize that comparatively low subprime default rates were dependent upon rising home prices and low interest rates and based their assessment of the riskiness of mortgage backed securities on the unrealistic assumption that home prices would continue rise and interest rates remain low indefinitely.
What has the Fed done with regard to monetary policy to address the economic downturn resulting from the subprime crisis? What is your assessment of how Ben Bernanke has handled the situation? After the housing bubble burst in the summer of and the credit crunch set in, the Fed began a series of interest rate cuts in the fall of in an attempt to stimulate lending, arguing that the downside risks to the economy outweighed concerns over rising inflation.
Continuing financial woes and tight credit markets persisted, however, prompting the Fed to step up the pace and degree of interest rate cuts, slashing the Federal funds rate on January 22, by three quarters of a percentage point to 3.
Rate cuts continued throughoutsettling at 0. Overall, Ben Bernanke has done admirable job in handling the subprime crisis, acting swiftly to lower interest rates to loosen tightening credit markets and standing up to critics that accused him of irresponsibly ignoring the threat of rising inflation posed by his policies.
He clearly recognized the grave implications of the subprime crisis for the global economy and did not dither when it came to policy actions to stimulate lending in the financial markets. What fiscal policy actions have been taken to address the economic downturn?
What additional fiscal policy actions should be taken? Many experts argued that the stimulus was not timely enough to address the crisis, and others pointed out that early surveys revealed most potential recipients did not intend to spend their rebates, but rather planned to save them or use them pay off bills.
The Bush stimulus did cause an uptick in consumer spending in the second and third quarters ofthough it was short-lived and seemed to do little alter the downward course of the economy.
Clearly, given the severity of the economic downturn and the seeming impotence of monetary policy, a more expansive fiscal stimulus is necessary, one that incorporates increased government spending along with tax cuts aimed directly at stimulating consumption, such as tax-incentives for home improvements and new car and home purchases.
If you were advising top lawmakers in Washington about potential policy responses to the subprime mortgage crisis and ensuing recession, what advice would you offer? If the link does not work, copy the address below and paste into your browser.A Model of Unconventional Monetary Policy Mark Gertler and Peter Karadi NYU April (This Version, April ) such as mortgage-backed securities, the costs of central bank intermediation The core framework is the monetary DSGE model with nominal rigidities developed by CEE and SW.
To this we add nancial intermediaries that. Monetary theory is governed by a simple formula, MV = PQ, where M is the money supply, V is the velocity (number of times per year the average dollar is spent), P is the price of goods and.
Overly loose monetary policy, poor regulation of financial markets, the overexpansion of the subprime mortgage market and accompanying housing bubble, and the rapid growth of complex financial derivatives based on pooled mortgage loans all played significant roles in bringing about the crisis.
The Bank Lending Channel of Monetary Policy and Its Eﬀect on Mortgage Lending Lamont K. Black, Diana Hancock, and Wayne Passmore response of banks to monetary policy in the context of mortgage funding and mortgage lending.
We focus on lending in subprime communities, because it is a form of Using a model similar to . cation about monetary policy. To be sure, there were some important developments in between the tra- ditional macroeconometric models and the most recent vintage.
A Model of Unconventional Monetary Policy Mark Gertler and Peter Karadi NYU April (This Version, November ) Abstract mortgage-backed securities, the cos ts of central bank intermediation might be relatively low. In this case, direct central bank intermediation may be.