Question

The following graph depicts US central bank's total assets and excess reserves of banks FRED -Excess Reserves of Depository Institutions -All Federal Reserve Banks-Total Assets, Eliminations from consolidation 5 Mil 4 Mil 3 Mil 2 Mil 1 Mil 1 Mil 2008 2010 2012 2014 Shaded areas indicate US recessions - 2014 research.stlouisfed.org a) Use the above graph to determine what kind of interventions the central bank undertook. (Hint: Depict the change in a central bank's balance sheet.) b) Depict this intervention in the supply and demand diagram for Reserves (US equivalent of ESF) to determine the impact on the federal funds rate (US equivalent of the cash rate).

Answer 1

(a) Given the diagram, we find that post 2008 and 2009 recession the US Fed indulged in asset buying program and thus total assets increased with substantial difference in reserves. Since the Fed Us Fed bought back assets it increased money supply in market and eliminated cash crunch caused due to recession in quantitative and gradual manner. (b) This policy is termed as expansionary monetary policy which tends to increase monetary supply of money. since money is now available easily the demand for money gradually decreases causing federal funds rate to come down as part of expansionary monetary policy