discussion 5 monetary stimulus and the asset bubble

MONETARY STIMULUS: THE FEDERAL BUBBLE MACHINE 1. Go to the St. Louis Fed’s web site and look at the graph of target federal funds rates over the last few years: http://research.stlouisfed.org/fred2/series/DFEDTA… Notice that from January 2001 until June 2003, the Fed lowered the target federal funds rate in steps from 6.5% all the way down to 1% and left it there for a year; then between June 2004 and June 2006 they raised the rate back up to 5.25%; and then finally from September 2007 until now, they lowered the target federal funds rate again in steps down to almost zero. WHY did the Fed do this? What is the intended effect of either lowering or raising the federal funds rate? 2. Explain the mechanism: what does the Fed actually DO (beyond making public pronouncements about their intentions) to lower or raise the federal funds rate from wherever it is? 3. What are the side effects, in the short run and the longer run, when the Fed does what you described in (2)? 4. We have recently had a major nationwide boom (a “bubble”) in residential real estate and in the financial markets in general, which has come to an abrupt and painful end. Is there any connection between this bubble and its end, and Fed actions as shown in the graph you looked at in (1)?

 

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