Macroeconomics and Direct Lending in Market Operations Since February 2008 the Fed has been supplementing its open market operations with a greatly expanded program of direct lending (both overnight...

Macroeconomics and Direct Lending in Market Operations

Since February 2008 the Fed has been supplementing its open

market operations with a greatly expanded program of direct lending (both

overnight and short term 28 and 84 day loans) to commercial banks and

commercial bank holding companies It also initiated a program to buy

commercial paper from money market funds

A) Explain how this expanded Federal Reserve lending and

commercial paper purchases affect supply and demand conditions in the Federal

funds market

B) As conditions in short term financial markets have

improved the volume of funds lent under these programs by the Fed has decreased

from a high of 15 trillion to about 600 billion outstanding However, the Fed

has increased substantially its purchases of longer term mortgage backed

securities and treasury notes from banks Thus, bank reserves are still vastly

higher than then they were a year ago at this time Why has this huge increase

in reserves not touched off a surge in inflation?

C) Once economic conditions improve and lender & borrower

confidence levels start to return to normal how will the Fed’s ability to pay

interest on bank’s reserve deposits help it prevent a sharp, inflationary, rise

in the growth of lending and spending?