Ruipeng and intentions toward future short-term interest rates.

Ruipeng Tan

 

1) On the beginning of the speech, she mentioned that FOMC faces two
key challenges. one is the quest for maximum employment and price stability in
Congress. If the main tool of our regular policy is reduced to essentially
zero, it will weaken the US economy. The first challenge is led to the second
one, which is how to ensure that we can reduce the monetary policy in an
orderly manner when it is no longer needed. If we cannot do it the ability to
promote maximum employment and price stability will be reduced.

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And then,
she mentioned how they solve the problems. According to the first challenge,
they use monetary policy regulation to strengthening long-term interest rate
guidance and large-scale asset purchases. In order to face the great recession,
Fed is going to remove the policy.

what is
more, she mentioned two unconventional monetary policy tools to face the great
recession. There is forward-looking guidance on large-scale asset purchases and
intentions toward future short-term interest rates. And FOMC is working on
lowering long-term interest rates is to help the U.S. economy recover from the
recession and curb deflationary pressures.

According to
face future crisis like great recession, FOMC will use the impact of short-term
interest rates on the federal funds rate as the primary tool.

Overall,
because of the great recession, Fed face two main challenges, which is FOMC had
to provide additional policy controls after its short-term interest rates had
reached their effective lower limit and FOMC had to reduce the accommodation
while expanding the federal reserve balance sheet.

 

2)

A) Frist, 1 pound= 1.68 dollar

Investment
amount on 7/15= 100 million dollars= 100/1.68=59.52 million pounds

The interest
rate on 1 year CD on pound is 0.02

1 year later
the exchange rate is 1.55 per US/ pound

Investment
amount after 1 year= (1+ 0.02) *59.52=60.71 million pounds *1.55= 94.10 million
dollars

loss=
94.10millon- 100 million= -5.9 million dollars

rate of
return= -5.9/100=-5.9%

Therefore,
have a negative return of 5.9% on the investment

 

B) If CFO invest in the US CD, the amount after 1
year will be 100*0.5%=100.5 million dollars, because of the question A will
know that the amount after 1 year UK CD is 60.71 million pounds. Thus, in
order to make profit, the expected exchange rate of pound should be greater
than 100.6/60.71=1.65 USD per pound

 

 

3)

It is because the Fed
faced the great recession in 2008 and 2009. Due to the great recession, the
traditional monetary policy tools didn’t work so well, Fed have to use an
aggressive monetary policy and this situation is called a liquidity trap.

Central
bank is the one who control the open market operations. They use the open
market to influence the money supply in the economy. Usually, the central bank
buys or sells government bonds to affect short-term interest rate in the
economy. However, liquidity trap is the one who injected cash into private
banking system, so central bank cannot reduce the interest rate to make the
monetary policy loss efficacy. In liquidity
traps, consumers will avoid bonds and save money because it is widely assumed
that interest rates will rise quickly. This
helps to reduce interest rates uniformly across asset groups, thereby freeing
borrower’s higher interest rate burden and creating new demand.

 

4)

A) Based on the information above, when can imaging that after
the recession, the level of confidence of lenders and borrowers started to
return to normal levels and the level of investment rose sharply which causes the economy to increase its money
supply too fast and the dollar demand has increased. As a result, the dollar
value has risen. The Fed’s three QE have increased the money supply. Due to
huge investment, the size of the Fed’s long-term US Treasury bonds and
mortgage-backed bonds has increased, and the Fed’s portfolio has increased
substantially. The problems faces are that the economy is rising inflation, bank
deposits and deposits increasing.

 

B)

One of the tool to help solving this problem
is raising the cash reserve ratio and the statutory liquidity ratio.

It will reduce the ratio of excess reserves to commercial banks. When the bank
borrows less cash, the money supply will decrease.

 

5)

A)

Although the Fed must consider the effect on the
inflation rate, unemployment rate and so on in order to take appropriate
action, in this case the main consider perspective should be the currency value.

Because the dollar exchange rate is mainly determined by changes in the foreign
exchange market D and S, the Fed usually do not want to manipulate the exchange
rate under normal economic conditions. If domestic currency rate goes up, it
helps the economy as well as causes some trouble. For example, if US $ becomes
stronger than other currencies and pays in your home currency, you should pay a
higher amount. This can lead to increased product costs and to inflation. And
there is a condition in the question mentioned that the value of dollar is increasing
against Euro, RMB and Yan. Therefore, the only currency that dominates
international trade is the United States dollar. As a result, the global market
will see increased demand for the U.S. dollar. Therefore, maintaining the present value of
the U.S. dollar is good for the U.S. economy.

 

B)

 

 

In P0, it reaches the full employment, when
the dollar rise, AD will decrease as graph shows, AD will shift to the left.

 

6)

When comparing interest rates, usually long
deposit rates will be higher due. And the LT interest rate is risker than the
ST. In this question, both bonds are zero coupon bond, and the 1 year US
treasury securities is 0.28% and the 2- year one is 0.69%, thus the expectation
of 1 year yield is

(1+0.0069)^2=(1_0.0028)*(1+x)

1.011=1+x

x=0.011=1.1%

Thus, the data suggest the interest rate at
one year later should be higher.

 

7)

A) A long-term
state of the US is that budget deficit= G-T>0 which means that G is higher
than tax every year. In the question, there is a condition that budget deficit
is almost $19 trillion, but it is good for the economy growth. One of the
argument could be G is too high, so the AD has increase, but not so much tax
revenue leading to budget cannot balance. From my perspective, we can increase
the tax payment for high-income people in order to reduce the deficit.

 

 

B) No, it is not. When the budget deficit high, the inflation rate
will be higher and the economy will be unstable. And both of them are use their
way to reduce the deficit. In the other perspective, the deficit can help the
economic grow.

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