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Unformatted text preview: 9-28- 2009 The Blob That Ate Monetary Policy WSJFans of campy science fiction films know all too well that outsized monsters can wreak havoc on an otherwise peaceful and orderly society. But what B-movie writer could have conjured up this scary scenario—Too Big To Fail (TBTF) banks as the Blob that ate monetary policy and crippled the global economy? That's just about what we've seen in the financial crisis that began in 2007. While the list of competitive advantages TBTF institutions have over their smaller rivals is long, it is also well-known. We focus instead on an unrecognized macroeconomic threat: The very existence of these banks has blocked, or seriously undermined, the mechanisms through which monetary policy influences the economy.Economics textbooks tell us that when the Federal Reserve encounters rising unemployment and slowing growth, it purchases short-term Treasury bonds, thus lowering interest rates and inducing banks to lend more and borrowers to spend more. The banking system, and the capital markets that respond to these same signals, are critical to transmitting Fed policy actions into changes in economic activity. These links normally function smoothly. Numerous academic studies have concluded that monetary policy before the financial crisis was working better, faster and more predictably than it did a few decades ago. Monetary policy's increased effectiveness helped usher in a quarter century of unprecedented macroeconomic stability often called The Great Moderation—infrequent and mild recessions accompanied by low inflation.Then the Blob struck. With financial markets in trouble and the economy wobbling, the Fed began lowering its target interest rate two years ago, bringing it close to zero by December 2008. Other central banks followed suit. Based on recent experience, such aggressive policies should have fairly quickly restored stability and growth. Unfortunately, the Blob was already blocking the channels monetary policy uses to influence the real economy....
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This note was uploaded on 02/22/2012 for the course MANEC 453 taught by Professor Jerrynelson during the Winter '10 term at BYU.
- Winter '10