The Multiplier Effect, Research Paper Example

In the 2009 Federal Reserve acquisition of $1.25 trillion in agency mortgage-backed securities, the Fed has pledged to reduce the “pace” of these purchases. This decision comes into being because the Fed anticipates that “including low rates of resource utilization, subdued inflation trends, and stable inflation expectations” (Press Release, 2009, para. 3) are anticipated as the overall federal funds rate may be at an all-time low in the U.S. economy. This “buyback” may in turn allow banks to better handle loss of mortgage’s that have gone bankrupt or, conversely, this may further dampen a market that is already in financial straights and this bailout will further perpetuate the problems. In open-market operations has the Feds buying bills, bonds and notes that may in turn increase the money supply. The Fed must keep in mind however that selling securities back to the bank in an open-market trade may in turn lead to “decrease in investment” which limits capital access to funds and this will indubitably slow down the economy (Balasubramaniam, 2011, para. 5). The limits of the money multiplier may detrimentally affect a bank’s ability to seek out aid from the Fed through open-market operations. Such ventures have lead to significant crashes in a ratio in which every $1 sees a significant increase of $.95 which makes banks hold on to their reserve with an even tighter hold (Open Market Operations, 2007, para. 3). As banks continue to build up their reserve, this in turn decreases the amount that is being lent out. This example was seen with the collapse of the Lehman Brothers company. Thus, Fed money isn’t being used to help mortgage rates, or to be lent out once obtained by the banks, but rather being horded by banks in their own reserves in order to simply exponentially increase.

References

Balasubramaniam, K. (2011, 26 April). How do open market operations affect the U.S. Money supply? Investopedia. Retrieved from http://www.investopedia.com/ask/answers/06/openmarketoperations.asp

Open Market Operations. (2007). Federal Reserve Bank of New York. Retrieved from http://www.newyorkfed.org/aboutthefed/fedpoint/fed32.html

Press Release. (2009, 16 Dec.). Board of Governors of the Federal Reserve. Retrieved from http://www.federalreserve.gov/newsevents/press/monetary/20091216a.htm

Timberlake, R. (2009). The Original Federal Reserve System. The Concise Encyclopedia Of Economics. Retrieved from http://www.econlib.org/library/Enc/FederalReserveSystem.html