Academic journal article Journal of Economics & Management

Monetary Policy of the Federal Reserve System from the Perspective of Exit Strategies 1

Academic journal article Journal of Economics & Management

Monetary Policy of the Federal Reserve System from the Perspective of Exit Strategies 1

Article excerpt


Central banks of the largest countries in the world are now starting the implementation of the exit strategies, which are the process of normalization of monetary policy. Nowadays, the primary objective of central banks' activities is to restore monetary policy to framework before the crisis. At the same time, central banks are faced with the challenges of the need to absorb the liquidity, provided to commercial banks during the crisis, in order to prevent inflation and support economic recovery. The pace of monetary policy normalization process depends on the market reaction to the central bank's decisions and macroeconomic conditions, in which they will be implemented. Therefore the process of monetary policy normalization is extremely difficult and complicated.

Especially that non-standard and unconventional monetary policy, implemented during the global financial crisis has never been implemented in any country on such a large scale [Chari 2010]. The main aim of the study is to present the principles of the exit strategy of the American central bank - the Federal Reserve System (Fed), on the background of the changes that have occurred in the United States within the monetary policy during the global financial crisis. The study used the following research methods: literature studies, document analysis method, synthesis method and cause and effect method.

1. Preface to the discussion

During the global financial crisis, non-standard and unconventional monetary policy of the Federal Reserve System was aimed to increase the liquidity of the banking sector, reducing the cost of lending, preventing the loss of liquidity of the banking institutions, which might lead to their insolvency or even bankruptcy. From the macroeconomic point of view, monetary policy focused on supporting the economy and counteracting recession. The first instrument implemented by the Fed immediately after the outbreak of the financial crisis was the Zero-bound interest rate policy. At that time Federal Reserve System was the first central bank in the world, which decided about rapid and significant reduction of main interest rates [www3]. In December 2008 Federal Open Market Committee (FOMC) from the Federal Reserve Board lowered the base rate - federal funds rate, to the level of 0,00%-0,25%. Federal funds rate has never been reduced below 1% so far. These activities were associated with rapidly worsening problems of liquidity on the interbank market and the perspectives of recession of the American economy. Figure 1 shows the changes of the basic interest rate of the American central bank: the federal funds rate and the daily federal funds rate in the years of 1999-2014.

In addition to lowering main interest rates, there were made changes in the existing FED's instrumentation. Since October 2008, there have been implemented the interest rate of funds, transferred from depository institutions to the central bank. Central bank paid interests not only for the amount of the required reserves, but also for additional funds - excess reserves, held in accounts in the monetary authority [Domestic Open Market Operations During 2009, 2010, p. 4]. In December 2008 interest rate was set at the level of 25 basis points.

During the spread of the global financial crisis, decision on decreasing the base interest rate to almost zero-bound level, was not the only one non-standard Fed's initiative. Central bank of the United States during the global financial crisis implemented Quantitative Easing Policy (QE), by special asset purchase programs in three phases. Although Quantitative Easing policy was also used in other countries (such as in the UK), the scale of its use in the United States was the largest in the world. The result of unconventional assets purchase from commercial banks was "swelling" the Fed's balance sheet. Changes in the balance sheet of the central bank concerned both the size and the structure of assets and liabilities of the monetary authority. …

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