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Federal Reserve System and the World Financial Crisis

The world financial crisis of 2008, which started with the collapse of the US stock markets, eventually made the Federal Reserve System the safest place for banks to store their assets. Despite the fact that Fed is often blamed for making this crisis possible, Fed’s quick and elaborate response to the upsurge of adverse developments in the American economy deserves due attention.

At the beginning of the crisis in 2007, central banks were forced to take on the financial obligations to ensure the liquidity of the banking system. The traditional instruments to regulate the interest rate were not working. The conditions were aggravated by the panics of the market participants who were unsure of “the future value of assets, and how their own needs for capital and liquidity might evolve” (Kohn 2). The Fed had to search for innovative approaches and, thus, among others, established new lending procedures, which were reflected in the Term Auction Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility (Cecchetti 52).

The Fed lowered the credit interest rates almost to zero and issued huge amounts of low-interest loans to help the various institutions overcome the crisis. Besides, it reevaluated its policy considering inflation expectations; the expectations became firmly anchored, more realistic and more thoroughly monitored (Kohn 11).

Bernanke notes that, apart from state-secured short-term credits, those were “large-scale purchases of Treasury and agency securities” (“Federal Reserve’s Exit Strategy” par. 4) that helped to revive the economy by lowering the mortgage interest rate. This mechanism can also signal the investors about future financial risk, for instance, deflation. Since 2008, there were some large-scale asset purchases, focusing on mortgage-based securities and agency debts. However, Bernanke suggests that there is a number of threats those nontraditional monetary policy tools impose, including disruption of securities markets, threats to financial stability because of some investors’ “imprudent reach for yield” and possible financial losses of the FRS in case of unexpected rise in interest rates (“Monetary Policy since the Onset of the Crisis” 11-14).

Comparing the monetary policies of the US since 2007 and of Japan in the crisis of the 1990-s, Ueda points out to many similarities in the methods and differences in the results. The crises in both countries were caused by the financial bubble evolving from the real estate market boom. Both countries applied nonconventional monetary methods; however, the US governors acted more aggressively that helped to keep the inflation rates and the whole financial system more stable, while Bank of Japan decided to abandon attempts to cope with deflation (Ueda 198).

After experiencing the hardships of the 2008 financial crisis, the FRS has been developing a range of additional tools for reduction of the quantity of excessive reserves in the banking system. Among such tools are reverse repurchase agreements and term deposits. In the first case, the FR sells securities with further ability to repurchase them once in future; the second tool is offered to depository structures for a particular period (“Federal Reserve’s Exit Strategy” 15-16).

Since 2008, Fed has substantially reduced its payments for the purchased assets in printed money; instead, Fed explored the mechanism of electronic credits: “The answer is that the Fed simply credited the accounts that banks that are members of the Federal Reserve System hold with the Fed” (Barnett par. 4). Previously, banks would monitor the changes in the reserve flows to gain extra profits on the changes. In the new system, banks do not earn on cash withdrawals but are paid interest on excess reserves stored within the Fed (Barnett par. 6-7).

Overall, it can be seen that the Federal Reserve System has proved to be rather efficient in the short run. Thanks to nontraditional instruments of monetary policy, the Fes managed to preserve relative financial stability in the times of recession. However, due attention should be paid to long-term fiscal measures.

Works Cited

Barnett, Megan. How the Fed Prints Money without Any Ink. 2011. Web.

Bernanke, Ben. Federal Reserve’s Exit Strategy. 2010. Web.

Bernanke, Ben. Monetary Policy since the Onset of the Crisis. 2012. Web.

Cecchetti, Stephen. “Crisis and Responses: The Federal Reserve in the Early Stages of the Financial Crisis.” Journal of Economic Perspectives 23.1 (2009): 51-75. Print.

Kohn, Donald. The Federal Reserve’s Policy Actions during the Financial Crisis and Lessons for the Future. 2010. Web.

Ueda, Kazuo. “Deleveraging and Monetary Policy: Japan since the 1990s and the United States since 2007.” Journal of Economic Perspectives 26.3 (2012): 177-202. Print.