In the past years (specially before 2021), the Federal Reserve System of the United States and the government applied deregulation in the financial systems, ultra-loose monetary policy, and sometimes applied unconventional monetary policy including bailouts. Actually, their aim of applying these theories was to bloom the economy of the US. But unfortunately, these actions may cause to create bubbles in the financial market and they increase the risk in the financial market. In this study, I’m going to discuss this situation.
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According to the opinion of Neel Kashkari, the president of the Minneapolis Fed and a United States Treasury, there should be more strict regulations to prevent the ultra-loose monetary policy of the Federal Reserve System, in other words, the central bank system of the United States (Politi, 2020).
Deregulation in the financial systems in the United States
Deregulation of the financial markets means, reducing the rules and regulations that are implemented toward the financial markets by the government. As an example, we can say reduce the legal barriers to entering the financial markets. The United States has applied deregulation theory and now we can see there is a larger number of different financial institutions. This has made more complex the US financial market more because of the difficulty of coordinating of financial institutions.
Ultra-loose monetary policy in the United States
Also, for the past years, the Federal Reserve System has applied ultra-loose monetary policy with the influence of the government. Loose monetary policy, in other words, expansionary monetary policy means to apply the monetary policy for the increasing of aggregate demand of the nation with the intention of increasing the real output of a nation. For the loose monetary policy, a central bank can apply three major tools. They are, decrease the interest rates, decrease the statutory reserve requirements, and buy the government securities which are in the hands of the people.
According to the details that are provided by the Financial Times, the central bank majorly applied a lower interest rate policy. Because of this, people and business organizations have increased their demand for loans since there is a lower cost of the borrowings. This caused to increase in domestic consumption by the people and an increase of private investment by the business organizations. The central bank of the United States also applied the other two tools, decrease the statutory reserve requirements and buy the government securities which are in the hands of the people. As a result of them, the aggregate demand of the nation has increased. The government of the US hoped that increasing aggregate demand can increase the real output level of the US by a higher amount. In other words, the government hoped for a higher level of economic blooming.
Unconventional monetary policies in the United States
Also, within the past years, we can see that the US has applied “unconventional monetary policies”. That means, applying monetary tools other than traditional monetary tools. We can identify statutory reserve requirement ratio, interest ratio, and buying and selling of government securities as the traditional monetary tools.
But in unconventional monetary policies, the central bank uses different tools such as negative interest rates, quantitative easing, credit easing, and so on. So, the central bank of the US has purchased a higher amount of toxic assets which were owned by bankrupt companies or companies that have closed their account because of the higher financial losses. This action is called a “bailout”. Specially, within the period 200 -2018 financial assets of the US central bank has been increased from 400% because of the buying toxic assets and that has multiplied the money of the country. (Trinh, n.d.)
Also, because of the “bailout”, the central bank of the US has to pay interest to the shareholders of the bankrupt companies. This has increased the “reserve liabilities” of the US central bank’s balance sheet. (Howden, 2010). So, “bailout” also kept the US economy at a higher risk. Because if a private financial institution becomes lost, the central bank can buy its toxic assets of it. But, if the central bank becomes bankrupt, that will cause an economic crisis.
Impact of the deregulation, ultra-loose monetary policy , and unconventional monetary
Because of the above-mentioned activities of the central bank of the US, the economy is going to a “bubbling” situation rather than “blooming”.
Difference between “bubbling” and “blooming”.
We know that blooming means increasing the real output level of an economy. But bubbling is not like this. Bubbling means increasing the price of investment assets than their normal prices. (Hattangadi, 2017).
Because of the higher prices of investment assets, people decrease the amount of investment. Also, banks hesitate to provide funds to other banks and businesses because of the decreasing investment. Then the prices of the investment suddenly decreasing. The bubble will be burst. Then the whole economy will become to the worst situation. This was what happened in 2008 because of the collapse of Lehman Brothers Company. (Sraders, 2018) So, both the central bank and government of the US should consider this critical situation and must take action before the bubble will be burst. If not, households and business organizations will become financially lost. Income distribution disparity will be increased.
What Federal Bank should do?
So, the central bank can apply tougher monetary policies such as increasing the interest rates, increasing the statutory reserve requirement ratio, and sell government securities to the people. Also, the government should increase the laws and regulations towards the financial market. Further, before the central bank buys the toxic assets, it should be done a broad financial feasibility analysis of the central bank. According to the forecasting of the analysis, if there will be a financial loss, that bailouts should not be bought. If the US government and central bank understand this situation, they will able to save their economy as well as the whole world economy.
Hattangadi, V. (2017, June 26). What is the difference between economic bubble and economic boom? Dr. Vidya Hattangadi. http://drvidyahattangadi.com/what-is-the-difference-between-economic-bubble-and-economic-boom/
Howden, D. (2010, August 4). Can the Fed unload its toxic assets successfully? Christian Science Monitor. https://www.csmonitor.com/Business/The-Circle-Bastiat/2010/0804/Can-the-Fed-unload-its-toxic-assets-successfully
Politi, J. (2020, October 17). Subscribe to read | Financial Times. Www.Ft.com. https://www.ft.com/content/5c2b7d15-7e37-475a-8d42-1e8e0a3b8708
Sraders, A. (2018, September 12). The Lehman Brothers Collapse and How It’s Changed the Economy Today. Stock Market – Business News, Market Data, Stock Analysis – TheStreet. https://www.thestreet.com/markets/lehman-brothers-collapse-14703153
Trinh, H. (n.d.). How banks have set a trap for the U.S. Fed by creating money. The Conversation. https://theconversation.com/how-banks-have-set-a-trap-for-the-u-s-fed-by-creating-money-100226