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The Great Recession

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The awakening of the Great Recession was signaled by the burst of the housing bubble where individuals found themselves in heavy debt due to a fall in the prices of their assets–a decline in housing wealth and income. The burst of housing bubble shrank GDP below its 3% average which resulted in a contraction of residential investment that reduced overall demand for goods and services in the economy by roughly $420 billion. This financial crisis had the central bank and government authorities in search for the most effective way to resolve the large loss in GDP and increase in unemployment as well as stabilizing the economy. Expansionary measures in both monetary and fiscal were undertaken, and these policies were successful in recovering the …show more content…

Monetary policy is considered to be a simpler implementation in the sense that its policy tools are primary levers that the Federal Reserve already has control over. The Federal Reserve can conduct monetary policy through open market operations which involve purchasing of existing U.S Treasury securities in the secondary market, Federal Reserve can also change reserve requirements (i.e. amount of customer deposits banks must hold as vault cash), and finally Federal Reserve can change interest rates directly that influence market rates. The policy tools for conducting monetary policy is not overly difficult, it is rather flexible and convenient for the Federal Reserve to set and change, thus monetary policy became a primary response coming from the Federal Reserve during an economic …show more content…

The Federal Reserve reduced the federal fund rate to nearly zero, reaching the zero lower bound, a classic example of liquidity trap, simply could not help the economy. Even with a zero-fund rate, given the low expectation of low inflation, the real interest rate which becomes the negative of expected inflation may be too high to offset individuals’ insecurity about their future income or economy growth. Also with a zero-fund rate, monetary policy becomes contractionary if the natural rate lies below the negative value of expected inflation or real rate exceed the natural rate. This was essentially what happened during the Great Recession, having interest rate too low reaching a zero lower bound which does not benefit the economy but functions the opposite. Aggressive monetary easing also came with a risk which was causing high inflation. Indeed, inflation reached higher levels during the time of crisis, this rapid monetary easing would translate into higher prices and not higher output in the

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