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Lecture4: TheAftermathoftheCrisis

TheFedsEffortsto RestoreFinancialStability
Afinancialpanicinfall2008threatenedthe stabilityoftheglobalfinancialsystem. Initslenderoflastresortrole,theFederal Reserveprovidedliquidity(shortterm collateralizedloans)tohelpstabilizekeyfinancial institutionsandmarkets.
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TheFedsEffortsto RestoreFinancialStability
TheFedworkedcloselywiththeTreasury,other regulatoryagencies(suchastheFDICandSEC). Coordinationwithforeigncentralbanksincluded thecreationofforeigncurrencyswaps.
TheFedprovideddollarstoothercentralbanksin exchangeforforeigncurrencies. Theswapsenabledforeigncentralbankstomeetthe dollarfundingneedsoftheirownfinancial institutions.

TheFedsContinuingEffortsto StrengthentheBankingSystem
TheFedledstresstestsofthe19largestU.S. banksinthespringof2009,whichhelpedrestore investorconfidenceandallowedbankstoraise about$140billioninprivatecapital. RecentstresstestsconductedbytheFedshowed substantialfurtherimprovementsinbankcapital andbanksresiliencetoshocks.

EvaluationoftheSpecial LenderofLastResortPrograms
Results:Theprograms
arrestedrunsonvarioustypesoffinancial institutions restoredfinancialmarketfunctioning,restarted flowofcredit,andsupportedresumptionof economicgrowth

ProgramswerelargelyphasedoutbyMarch 2010.

EvaluationoftheSpecial LenderofLastResortPrograms
FinancialriskstotheFederalReservewere minimal:
Lendingwasmostlyshorttermandbackedby collateral;thousandsofloansweremade,none defaulted. Althoughtheobjectiveoftheseprogramswas stabilization,notprofit,taxpayerscameout ahead.

MonetaryPolicyduringtheCrisis
TheFedusedlenderoflastresortpolicytohelp stabilizethefinancialsystem.Tostabilizethe economyandpromoteeconomicrecovery,the Fedturnedtomonetarypolicy.

MonetaryPolicyduringtheCrisis
Conventional monetarypolicyinvolves managementofatargetshortterminterestrate (thefederalfundsrate).Becauselongerterm ratestendtofallwhentheFedlowerstheshort termrate,andbecauselowerlongertermrates tendtoencouragepurchasesoflonglasting consumergoods,houses,andcapitalgoods, cuttingthefederalfundsratehelpsstimulatethe economy.

MonetaryPolicyduringtheCrisis
MonetarypolicyisconductedbytheFederalOpen MarketCommittee(FOMC). TheFOMCmeetsinWashington,D.C.eighttimesa year.Duringthecrisis,itsometimesalsoheld unscheduledvideoconferences.

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MonetaryPolicyduringtheCrisis
TheFOMCconsistsof12members:
the7membersoftheBoardofGovernorsofthe FederalReserveSystem thepresidentoftheNewYorkFederalReserveBank 4oftheremaining11ReserveBankpresidents,who serveoneyeartermsonarotatingbasis

OtherReserveBankpresidentsparticipatein deliberationsbutdonotvote.
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Federal Funds Rate

FederalFundsRate

Tosupportthe recovery,theFed reducedthefederal fundsratefrom 5 percentin September2007to nearly zeroin December2008, whereithas remainedsince.
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LargeScaleAssetPurchases
Withthefederalfundsratenearzero,thescope forconventionalmonetarypolicywasexhausted. Buttheeconomyremainedweakandsome worriedabouttheriskofdeflation(fallingwages andprices).

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LargeScaleAssetPurchases
Toinfluencelongertermratesdirectly,theFed undertooklargescalepurchasesofTreasuryand governmentsponsoredenterprise(GSE) mortgagerelatedsecurities. Largepurchaseprogramswereannouncedin March2009andNovember2010. TheseactionsboostedtheFedsbalancesheetby morethan$2trillion.
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Federal Funds Rate

LargeScaleAssetPurchases

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LargeScaleAssetPurchases
WiththeavailablesupplyofTreasuryandGSE securitiesreducedbyFedpurchases,investors werewillingtoacceptloweryields.Lower longertermrateshelpedstimulatetheeconomy, justastheydounderconventionalpolicies. ReducedavailabilityofTreasuryandGSE securitiesledinvestorstopurchaseotherassets, suchascorporatebonds,loweringtheyieldson thoseassetsaswell.

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LargeScaleAssetPurchases
Thesesecuritiespurchaseswerefinancedby addingtothereservesheldbybanksattheFed; theydidnotsignificantlyaffecttheamountof moneyincirculation.TheFedhasmultipleways tounwindthelargescaleassetpurchases (LSAPs),includingsellingthesecuritiesbackinto themarket.
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Federal Funds Rate

LargeScaleAssetPurchases

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EffectsofLargeScaleAssetPurchases
LSAPs(alsoknownasquantitativeeasing) loweredlongerterminterestrates.
30yearmortgageratesfellbelow4percent. Corporatecreditbecamemoreavailable,andstock pricesrose.

Lowerlongerterminterestrateshelpedpromote recovery,thoughtheeffectonhousingwas weakerthanhoped.


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EffectsofLargeScaleAssetPurchases
TheFedscredibilityandlongstanding commitmenttopricestabilityhashelpedanchor inflationandinflationexpectations,whichhave remainedlow. Atthesametime,LSAPsguardedagainsttherisk ofdeflation(fallingwagesandprices).
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EffectsofLargeScaleAssetPurchases
TheFedsassetpurchasesarenotgovernment spending,becausetheassetstheFedacquired willultimatelybesoldbackintothemarket. Indeed,theFedhasmademoneyonits purchasessofar,transferringabout$200billion totheTreasuryfrom2009through2011,money thatbenefitedtaxpayersbyreducingthefederal deficit.
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MonetaryPolicyCommunication
Clearcommunicationfromthecentralbankcan helpmakemonetarypolicymoreeffectiveby helpinginvestorsbetterunderstandpolicygoals andbetteranticipatefuturepolicyactions.

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MonetaryPolicyCommunication
TheFedhas becomemore transparentabout monetarypolicy. Forexample,the Chairmanbegan holdingnews conferencesin 2011.

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MonetaryPolicyCommunication
TheFedalsohasrecentlyprovidedmore informationaboutitsgoalsandpolicyapproach (forexample,bydefiningpricestabilityas inflationof2percentinthemediumterm).

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MonetaryPolicyCommunication
TheFedhasalsobegunprovidingguidanceto investorsandthepublicabouthowitexpectsto adjustthefederalfundsrateinthefuture,given currentinformationabouttheeconomicoutlook. Thisguidancehelpsthepublicbetterunderstand theFOMCsviewsandpolicy.
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EconomicRecovery
Aidedbytheeffectsofmonetaryandfiscalpolicy aswellastheeconomysnaturalrecuperative powers,economicactivitybegantorecoverin mid2009. Sincethen,realGDPhasincreasedatanaverage annualrateofabout2percent.
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Federal Funds Rate

SluggishEconomicRecovery

Butthepaceof recoveryhasbeen extremelysluggish comparedwith previouspost WorldWarIIcyclical recoveries.

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Federal Funds Rate

SluggishEconomicRecovery

Asaresult,job prospectshave improvedonly graduallyandthe unemploymentrate remainspainfully high.

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Federal Funds Rate

SlowingtheRecovery:Housing

Whyhastherecovery beenslowerthan hoped? Aresurgenthousing marketnormallyhelps powereconomic recoveries,butnot thistime.

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Federal Funds Rate

SlowingtheRecovery:Housing

Factorsweighingon thehousingmarket include


acontinuinghigh foreclosurerate anoverhangof unsoldhomes fallinghouseprices

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Federal Funds Rate

SlowingtheRecovery:Housing

Verytightlending standardson mortgageshave bluntedsomeofthe effectsoflow mortgagerates.

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Federal Funds Rate

SlowingtheRecovery:Housing

Declininghouseprices discouragenew construction. Moregenerally,sharp declinesinhouse pricesmake consumersfeelpoorer, andthuslesswillingto spend.


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SlowingtheRecovery: FinancialandCreditMarkets
TheU.S.bankingsystemissignificantlystronger thanitwasthreeyearsago,andcreditismore availabletohouseholdsandbusinesses.

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SlowingtheRecovery: FinancialandCreditMarkets
However,difficultiesremainforsomeborrowers:
Forhouseholds,mortgagesaredifficulttoobtain forborrowerswithlessthanpristinecreditscores. Forsmallbusinesses,creditmarketconditions remaintightbutappeartohavebegunto improve.
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SlowingtheRecovery: FinancialandCreditMarkets
ConcernsaboutEuropeanfiscalandbanking conditionshavealsostressedfinancialmarkets andledtomoreconservativelendingand diminishedconfidence.

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LongTermEconomicGrowth intheUnitedStates
Thefinancialcrisisandrecessionwereamajor trauma.Manypeoplewhohavebeen unemployedforalongtimehaveseentheirskills erode.Andlongertermproblems,likerising federaldeficits,havenotgoneaway.

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LongTermEconomicGrowth intheUnitedStates
Ontheupside,however:
TheU.S.economyremainsthelargestinthe world,withahighlydiversemixofindustries. Oureconomyhasarobustentrepreneurial culture,withflexiblecapitalandlabormarkets.

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LongTermEconomicGrowth intheUnitedStates
Ontheupside,however:
Weremainatechnologicalleader,withmanyof theworld'stopresearchuniversitiesandthe highestspendingonresearchanddevelopmentof anynation. And,intheaftermathofthecrisis,wehave strengthenedourfinancialregulatorysystem.
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Federal Funds Rate

LongTermEconomicGrowth

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PostcrisisRegulatoryChanges
Thecrisisrevealedmanyimportantregulatorygaps andweaknesses. LehmanBrothersandAIGendangeredthefinancial systemandhighlightedtheneedfornewtoolsto addressproblemsatsystemicallyimportant financialinstitutions. Moreoversightofthesystemasawholewas needed.
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Federal Funds Rate

PostcrisisRegulatoryChanges

TheDoddFrank WallStreetReform andConsumer ProtectionActof 2010instituted wideranging reformsoffinancial regulationinthe UnitedStates.

Rep.BarneyFrank

Sen.ChristopherDodd

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KeyProvisionsoftheDoddFrankAct: SupervisionandRegulation
Theactexpandedthefinancialstabilitydutiesof financialregulators,includingtheFed:
ItcreatedtheFinancialStabilityOversightCouncil (FSOC)tohelpregulatorscoordinatetheirefforts. Itgaveallregulatorstheresponsibilitytotrackand respondtopossibleriskstothefinancialsystemas awhole.
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KeyProvisionsoftheDoddFrankAct: SupervisionandRegulation
Itclosedgapsintheoversightofthefinancial system:
TheFSOCcandesignatesystemicallyimportant nonbankinstitutionstobesupervisedbytheFed. TheFSOCcanalsodesignatekeyfinancialmarket utilities(forexample,stockexchanges)for enhancedsupervision.
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KeyProvisionsoftheDoddFrankAct: SystemicallyImportantInstitutions
Theactsubjectedsystemicallyimportantfinancial institutionstotoughersupervisionand regulation:
Highercapitalrequirementswereestablishedfor mostsystemicfirms. Bankaffiliatesareprohibitedfromtradingontheir ownaccount(Volckerrule).
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KeyProvisionsoftheDoddFrankAct: SystemicallyImportantInstitutions
Theactmadesystemicallyimportantfinancial institutionssubjecttotoughersupervisionand regulation:
Regularstresstestsarebeingconductedto ensurethatfirmswillhaveadequatecapitaleven inbadeconomicscenarios.

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KeyProvisionsoftheDoddFrankAct: SystemicallyImportantInstitutions
Italsotackledtheproblemoftoobigtofail financialfirms:
Neworderlyliquidationauthorityallowsthe FederalDepositInsuranceCorporation(FDIC)to closefailingsystemicfirmsinawaythatcauses lessdamagetothefinancialsystem.

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KeyProvisionsoftheDoddFrankAct: OtherFeatures
Theacttookstepstomakethefinancialsystem moreresilient:
Itrequiredmoretransparencyandstandardization ofderivativetransactions.

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KeyProvisionsoftheDoddFrankAct: OtherFeatures
Itcreatedanewagency(theConsumerFinancial ProtectionBureau)withbroadpowerstoprotect consumersintheirfinancialdealings. Financialregulatorsareimplementingtheseand otherprovisions,inconsultationwithforeign regulators.
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TheEffectsoftheCrisison CentralBankPractice
Inthedecadesbeforethecrisis,centralbanks oftenviewedfinancialstabilitypolicyasthe juniorpartnertomonetarypolicy. Thecrisisunderscoredthatmaintainingfinancial stabilityisanequallycriticalresponsibility.
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TheEffectsoftheCrisison CentralBankPractice
Financialcriseswillalwaysbewithus.Butas muchaspossible,centralbanksandother regulatorsshouldtrytoanticipateanddefuse threatstofinancialstabilityandmitigatethe effectswhenacrisisoccurs.

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Conclusion
Webeganbynotingthetwoprincipaltoolsand responsibilitiesofcentralbanks
servingaslenderoflastresorttopreventor mitigatefinancialcrises usingmonetarypolicytoenhanceeconomic stability

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Conclusion
TheFedandothercentralbanksusedbothtools extensivelyinthecrisisanditsaftermath.These toolshelpedpreventarepeatoftheGreat Depressionofthe1930sandsetthestagefora slowbutcontinuingeconomicrecovery.

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Conclusion
Anewregulatoryframeworkwillreduce,butnot eliminate,theriskoffinancialcrisesinthefuture. Greatermonitoringofpotentialsystemicrisks shouldhelp. However,therecentfinancialcrisisshowsboth thatacrisiscanbehardtoanticipateandthatit cancausemajordamagetotheeconomy.
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