The article “Macro Control, Micro Problems”
addresses the issue that the Federal Reserve faces in attempting to spur
economic growth by lowering interest rates and buying securities and bonds
without fueling risky behavior and excess in specific financial markets. The
article offers macroprudential policy as the remedy for this problem. Macroprudential policy asserts the
utilization of small-scale regulatory policy to prevent the generation of
excess in specific financial markets and limit the development of systemic risk
while reserving large-scale monetary policy to address inflation and employment.
In a very broad sense,
macroprudential policy seeks to regulate the supply and demand for credit. The
article’s illustration of how the Federal Reserve has historically regulated
the supply of credit in financial markets directly connects to concepts that we
are currently discussing in class. First, the Federal Reserve has employed
regulatory policy and interest rate ceilings to limit the loans made by banks.
In regards to banks, the interest rate is the return that the bank will earn
from making loans. Therefore, higher interest rates are incentive for banks to
increase lending. Immediately prior to the Great Depression, the Federal
Reserve ordered banks to cease excessive lending to stockbrokers spurred by
high interest rates—this action was a response to the dramatic increase of
speculation in the stock market. Even though there was a sharp decrease in bank
loans, total loans actually continued to increase as a result of the high
interest rates set by the Federal Reserve. Corporations operating outside the
jurisdiction of the Federal Reserve were prompted by the high interest rates to
take up the loans that banks could no longer make.
The Federal Reserve has also attempted
to set interest rate ceilings for banks. In this context, the interest rate is
defined as the return that households earn by depositing their money in
banks—the interest rate is the opportunity cost of holding onto money. This is
the definition of interest rates that we have become most familiar with in
class. In the 1950s, the Federal Reserve’s interest rate ceilings resulted in a
decrease in bank deposits. However, this unintended negative effect did not
surprise me. We have learned that as interest rates fall, there is a rightward
movement along the demand curve for money and the quantity demanded of money
rises. Lower interest rates cause the quantity demanded of money to increase
because the lower return from investment is not incentive for households to
take on the risk of depositing their money in banks.
Finally, the Federal Reserve has
utilized higher reserve requirements to control the supply of credit. As we
have learned, the reserve ratio is the portion of deposits that a bank is
required to keep as reserves. The article asserts that during the period of
1948 to 1980, higher reserve requirements resulted in a decrease in the growth
of bank credit. This is understandable considering that we have learned that
excess reserves are equal to total deposits minus required reserves. We have
also learned that excess reserves are used to make loans and investments.
Therefore, if banks were required to keep a higher percentage of deposits as
reserves, the funds unavailable for loans and investments would decrease.
According to what we have learned thus far about macroeconomic principles, the
reasoning behind raising reserve requirements to decrease credit supply is
sound. However, the negative growth produced from higher reserve requirements
between 1948 and 1980 was counteracted by the increase of lending by firms
outside the jurisdiction of the Federal Reserve.
I believe that the Federal
Reserve’s desire to address the economic issues of specific markets without
impacting the health of the entire economy is quite reasonable. Further,
macroprudential policy may be the solution to this issue. However, as is
evidenced by the examples provided above, macroprudential policy retains many
flaws at this time. While macroprudential measures may be able to address the
economic issues stemming from specific markets, the Federal Reserve has not yet
learned how to prevent such measures from having unintended effects on the
entire economy. Macroprudential policy demonstrates much promise as a powerful
monetary mechanism, but unfortunately it is still in the adolescence of its
development.
No comments:
Post a Comment