Day 232 The GFC and monetary policy in U.S.

The GFC and monetary policy in U.S.

The Global Financial Crisis(GFC) is also referred as the U.S. sub-prime mortgage market crush between 2007 and 2008. This is because the collapse on sub-prime mortgage companies leaded the domino effect on the global financial markets. The drastic crush on the Mortgage Backed Securities MBS hit the bank hard and generated the chain reaction on the U.S. economy. 

According to the data, the U.S. economy experienced a nil to negative growth on GDP during 2008 and 2009. Both consumer expenditure and investment suffered a decline during the same period. Especially in the residential investment market, the burst of real-estate bubble immensely reduced the investment on related area. In addition, the export and import have been hit as well. The government expenditure increased due to the fiscal stimulation plan in 2008 and 2009.  

In response to the crisis, the Federal Reserve Bank (FRB) has lowered the effective interest rate since the GFC, which indicates a typical expansionary monetary policy. In fact, the federal fund rate has been reduced to 0.16 percent in 2009, and this near-zero interest rate generated several effects. Firstly, the low interest rate boosted households’ expenditure, since there were fewer incentives for them to invest money. The interest rate is treated as the premium to compensate investors’ risk bearing, therefore, the reduced interest rate became insufficient to perform such function. Consequently, the consumers’ consumption increased, as well as GDP. Secondly, the low interest rate encouraged firms to borrow funds, due to the cost of borrowing decreased. These debt capitals transferred into the company's asset, which was anticipated to create future economic benefits and employment opportunities. Thirdly, the implication of monetary policy is achieved by open market operations, where the FRB buys and sells securities to alter the money supply. Hence the FRB expansionary policy from 2007 increased the money supply by purchasing government bonds, for the purpose to reduce the interest rate. Obviously, the government obtained more funds to use on the fiscal stimulation package, which made the economy better off. Fourthly, the low interest rate had a negative impact on demand of U.S. currency, thereby the deprecation on the exchange rate benefited the net export as well). As a matter of fact, this expansionary monetary policy was very effective. According to the data in previous section, the U.S economy recovered in 2010. The growth rate on GDP, personal consumption expenditures and gross private investment were successfully inverted back to positive. In addition, the export and import also started to increase. The government expenditure declined, corresponding to the reduced requirement on economy stimulation policy. Besides controlling the interest rate, the FRB also enforced the communication to shape the market expectation. Several actions were taken to provide investors better understanding of the expansionary policy, including the Federal Open Market Committee (FOMC) indicated that exceptionally low" levels of the federal funds rate were to be maintained for an 'extended period' in 2009.

In conclusion, this expansionary policy combined with other fiscal economy stimulation package immensely eased the crisis and helped the U.S. economy get back on track.