MONETARY POLICY

How the Global Financial Crisis 2007 was a result of

Loose Monetary policy in the US
MROL
AGENDAS FOR THIS PRESENTATION
What is Monetary Policy and types of Monetary Policy
Key Events Influencing to the Global Financial Crisis 2007
How Expansionary Monetary Policy led to the GFC 2007
The Response of the Federal Reserve
Conclusion
WHAT IS MONETARY POLICY
Expansionary or Loose
Monetary Policy
Attempts to promote aggregate demand
growth.
Reserve bank encourages private
consumption by Increasing the amount of
money in the economy,
When the quantity of money in circulation is
being rapidly increased, interest rates are
thus being pushed down which encourages
lending and investment.
The increase in consumption and
investment leads to a higher aggregate
demand.

Contractionary or Tight
Monetary Policy
Attempts to slow aggregate demand
growth.
The central bank discourages private
consumption by decreasing the amount of
money in the economy.
The quantity of money available is being
reduced, the interest rate increase, which
discourages lending and investment.
Higher interest rate promotes saving, which
further discourages private consumption.
The decrease in consumption and
investment leads to a decrease in growth in
aggregate demand.
Actions by the Reserve/Federal Bank to affect the price as well as the
quantity of money and credit in order to influence economic activity

KEY EVENTS INFLUENCING TOWARDS
THE GFC 2007

The bursting of the dot-com bubble, which saw the booming NASDAQ over
19982000 burst in 2001.
Fearing a downturn and possible deflation, the US Federal Reserve eased
monetary policy in 2001 in a series of steps till 2004.
Boom in house prices followed and a period of high growth in credit and
leveraged loans due to easy credit and a rising housing market
Rising demands from China (and, to some extent, India), plus a booming
world economy saw commodity prices rise across oil, minerals and food from
late 2004 to late 2007. The shock to the global economy from this commodity
price boom was as big as the first oil shock in the 1970s.
Rising prices and inflation caused monetary authorities to tighten policy from
mid-2004 to June 2006.

HOW DID LOOSE MONETARY POLICY
LED TO GFC 2007 IN THE US?

Due to the long term application of Expansionary Monetary policy by the Federal
Reserve
Started in 2001-2004
Gave rise to the asset price bubble and commodity price spike.
Led to the creation of the US housing bubble
Low interest rates
Adjustable-rate mortgages appeared to be very attractive to potential
buyers or prime buyers (responsible borrowers)
The Federal Reserve continued to liquidity into credit markets to ensure that
credit would continue to flow at low rates of interest
Support for the Sub-prime (most risky borrowers) market
Easier and cheaper low interest rate of from 2.8 in 2001 to 1.3% in 2007
(House of Commons Library 2009)

House of Commons Library (2009)
US National Home Price Index
1987-2008
HOW EXPANSIONARY MONETARY
POLICY LED TO THE GFC 2007
Loose monetary policy also led to imprudent mortgage lending caused by the
web of financial instruments.
When prices began to fall, loans started going bad.


Consequences:
The house prices started to fall
Number of foreclosures of houses rose dramatically
Bear Stearns announced a large loss, the fall of Lehman Brothers and a series
of fall of investment and insuring companies like AIG


THE RESPONSE OF THE FEDERAL RESERVE
Prior to September 2008
Governing institutions in the US primarily pursued to address liquidity concerns,
stimulate demand and prevent mortgage foreclosures. The main policy
responses included:
Lowering interest rates as well as a introducing number of liquidity-enhancing
schemes to abate the emerging credit crisis by the Federal Reserves
The orderly takeover of failed investment bank Bear Stearns
Stimulate demand and mitigate mortgage foreclosure.

THE RESPONSE OF THE FEDERAL RESERVE
CONT.
Response after October 2008
The Federal Reserve and the US Treasury became a key body in administering the
Emergency Economic Stabilization Act passed by Congress in October 2008. The
central features of the post-September response included:
Continuing efforts from the Fed to lower interest rates and increase liquidity;
Federal Reserve and US Treasury decision not to bail out investment bank Lehman
Brothers
Treasury-administered capital injections into troubled financial institutions in
exchange for preferred stock and common equity stakes
Sequence of bailouts by the Fed and Treasury for the insurance giant AIG;
The temporary suspension of the short-selling of financial institutions by the Securities
and Exchange Commission;
The Homeowner Affordability and Stability Plan, which permitted struggling
homeowners to refinance their mortgages

THE RESPONSE OF THE FEDERAL RESERVE
APPLICATION OF QUANTITATIVE EASY (QE) POLICY

Lower interest rates encourage people to spend, not save. But when interest
rates can go no lower, a central bank's only option is to pump money into the
economy directly, this quantitative easing (QE).
To revive consumer spending and economic growth
Cutting interest rates to raise the amount of lending and the economy indirectly
The way the central bank does this is by buying assets - usually government
bonds - using money it has simply created out of thin air.
The institutions selling bonds (either commercial banks or other financial
businesses such as insurance companies) will then have "new" money in their
accounts, which then boosts the money supply.

CONCLUSION
GFC revealed the importance of establishing conditions to ensure
the continuous functioning of the financial system

A long period of expansionary monetary policy should be avoided
as they could produce inadequate incentives

Central banks and other regulators should have a tight framework
of mortgage

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