Assignment:
Discussion 1
The Federal Reserves were using practices that they haven't used since the Great Depression. "First, the Fed extended credit to nonbank financial firms, which was the first time since the Great Depression that entities outside of the Federal Reserve System could borrow directly from the Fed"(Amacher Pate 2012). They did this so that all the small firms didn't fall because of the economy. "The Fed also purchased assets and loans from firms deemed "too big to fail." The purchases of mortgage-backed securities, loans ranging from millions to billions to financial firms like American International Group, and guarantees of the assets of Citigroup and Bank of America were all seen as unconventional practices of the Fed"(Amacher Pate 2012). That way they would have the money to used to help stabilize their financial state.
To support the firms that the Federal Reserve thought was to big to fail, they passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. "On July 21, 2010, President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law, which permanently raises the current standard maximum deposit insurance amount (SMDIA) to $250,000"(Amacher Pate 2012). This way when there will be less likely for the banks to be in a crisis because they would have more money to work with.
I think they did what they thought they had to do to keep the economy from collapsing. If everything started falling apart and they couldn't come up with a solution, they would have bigger problems to deal with than unconventional practices.
Amacher, R., Pate, J. 2012. Principles of Macroeconomics. San Diego, CA. Bridgepoint Education Inc.
The Federal Reserve was established to provide bank safety. Subsequently, the Federal Deposit Insurance Corporation (FDIC) was created to provide protection to bank depositors from bank failures. According to text, "it is important to allow unsuccessful firms to fail and leave the industry if the market system is to function effec¬tively" (Amacher, 2012, p. 343). In response to the numerous bank failures, the FDIC implemented several changes. First, it mandated that all accounts that are not interest bearing to be insured in full. Banks were using these funds to issue high interest loans, while paying minimal interest to funds that were deposited. Next, the Federal Reserve System was divided into 12 districts. This method ensured that control of the banks was not consolidated at a national level. At this point, the Federal Reserve can also adjust the interest rates to encourage or discourage banks from lending money. Also, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. This was the response for organizations who were deemed "too big to fail." This law required banks to have a high ratios of capital reserves, as well as reduce their penchant for risk
tasking.
Travis
References
Amacher, R., Pate, J., (2012). Principles of Macroeconomics. San Diego, California: Bridgepoint Education, Inc
Discussion 2
The Effect of Bank Lending on the Economy
A credit crunch is also known as a credit crisis and it happens when banks choose to not lend out of their reserves when interest rates are low and potential borrowers look too risky. This reminds me of the housing bubble that happened during the recession and how after the housing market crashed, there was a credit crunch on loans that seemed too risky for the purchase of a house. When there is a credit crunch, there is a reduction in the number of loans that are given and they are given at a much higher interest rate. Since there are tighter and stricter requirements during a credit crunch, there is an affect in economic growth from people not taking on loans for houses or to purchase a new car or even being accepted for a credit card and if they are it has a high interest rate. As a result of this, there ends up being more supply than demand of goods and services. During this time also, investors begin to pull out of investing in businesses that may seem risky. Unemployment begins to rise as a result of a credit crunch because aggregate demand and GDP also begin to decrease from companies going out of business and closing their doors subsequently reducing the number of finished goods made.
How does a credit crunch affect consumer spending and business investment? A credit crunch generally involves a reduction in the availability of credit independent of a rise in official interest rates. In such situations, the relationship between credit availability and interest rates has implicitly changed, such that either credit becomes less available at any given official interest rate, or there ceases to be a clear relationship between interest rates and credit availability. Many times, a credit crunch is accompanied by a flight to quality by lenders and investors, as they seek less risky investments (Amacher & Pate (2012), para 14.2-3).
How does a credit crunch affect aggregate demand, GDP, and unemployment? The crunch is generally caused by a reduction in the market prices of previously "overinflated" assets and refers to the that results from the price collapse. This can result in widespreadforeclosure or bankruptcy for those and entrepreneurs who came in late to the market, as the prices of previously inflated assets generally drop precipitously. In contrast, a liquidity crisis is triggered when an otherwise sound business finds itself temporarily incapable of accessing the bridge finances it needs to expand its business or smooth its cash flow payments (Amacher & Pate (2012), para 14.2).
references
Amacher, R., Pate, J., (2012). Principles of Macroeconomics. San Diego, California: Bridgepoint Education, Inc.