Question

Pre-2008 Policy Tools

1. required reserve ratio,

2. discount rate,

3. open market operations,

Address how the size and the composition of the Fed’s balance sheet have changed over the past decade and the implications for open market operations as a policy tool when the Fed has such a large balance sheet, i.e. when banks have such large quantities of reserves and you should explain how the Fed is approaching the process of normalization.

Please help

Answer 1

Balance sheet normalization refers to the Fed's efforts to sell off the huge holdings of assets it bought a decade ago to keep the economy afloat during the financial crisis.

In 2008 Fed faced a financial panic. The Fed reduced interest rates virtually to zero but that still wasn't enough to start an economy suffering its worst turmoil since the great depression.

Fed started buying long term treasury, debt and mortgage backed securities to " increase the availibility of credit " for home purchase. These purchase were termed Quantitative Easing. In 2017 Fed started selling off those holdings because the economy had recovered from that recession.

The use of Open Market Operations as a monetary policy tool ultimately helps the Fed pursue its dual mandate - maximising employment, promoting stable prices by influencing the supply of reserves in the banking system which leads to interest rate changes.