MONETARY POLICY
1. answer to the questions below: (Min 250 words) No quoting Answer based on knowledge of the topic
In November 2008, the Fed began to pay interest on reserves held at the bank.
o What effect would you expect on excess reserves?
o Did banks generally favor or oppose this action?
o Would central banks generally favor or oppose this action?
o What effect did this probably have on interest rates paid by banks?
.
2- Make constructive comment on each Response below: (betw 100-125words each)
Response 1
Excess reserves naturally tend to rise in bad times, and also fall in good times. If we look at the picture, as Fed began to pay interest on bank reserves, this should have been a reason for excess reserves to fall, because in this case bank reserves tend to rise.
When it comes to the banks, it’s clear that they favored this action by the Fed, and here is why: Fed pays interest on bank reserves, the capital of the people holding their money in the bank rises, which brings in more customers and investments to the banks, which also leads to the banks to favor in this situation.
If we speak about the Central Banks, in my opinion they opposed this action, because they are actually the ones paying interests. Federal Reserve itself is one of them. more interests paid on reserved, I think more central banks fall in the situation.
In general, I think the effect has been really positive from almost all angles. Well, if we don’t say positive, at least fair. After the crisis of 2008, many banks, and more the customers and investors themselves took many losses including on their investments in banks. So the Fed had to come up with an idea to solve all the major issues that were caused by the global crisis in 2008. If we look at the picture, at the time I think that Fed paying interest on bank reserves was the most proper idea to bring everything back to balance. I think both investors and banks favored in this situation.
Response 2:
a) Excess reserves are the bank reserves held by banks in excess of their reserve requirement which is defined by the central bank in the form of cash holdings or any credit balance at its federal reserve bank. If fed begins to give interest on fed reserves, then banks start to increase their excess reserves from the initial level.
b) The banks generally favor this action as they have started earning interest on the excess reserves which were not given earlier.
c) The central bank may or may not support this action. If the economy is in inflation like situation and the central bank needs to squeeze the money supply then it will oppose the action started by the fed bank as interest given by the fed bank will increase the money supply of banks and it will again increase the money supply in the economy by lendings or borrowings offered by the commercial banks and vice-versa.
d) The interest rate paid by the bank will probably increase on the deposits, as they have more amount to lend (due to interest rate on excess reserves) from the initial level and this will increase their profitability. Hence, it may be possible that banks start giving higher interest rates on the deposits (as they have more profit now) to attract more deposits.
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