Fed’s balance sheet

 Fed’s balance sheet

The composition of the Fed’s balance sheet is a crucial aspect of monetary policy at the time of crisis because it indicates how much liquidity and flexibility the Fed has to aid to spring the economy. When the Fed has a significant amount of debt and little in liquidity, it will be in a tough position during a crisis and may not be able to boost the economy (Plosser, 2018). They will also have limited tax revenue during a crisis, so it could increase the debt that is taken on by the Fed.

By purchasing specific kind of securities, the Fed can affect interest rates and liquidity in specific sectors of credit and financial markets, thus offering a more surgical provision of liquidity where it may be needed the most (as opposed to typical open market purchases, which add reserves to the global banking system). For instance, in relation to the global financial crisis, the Fed bought a significant amount of mortgage-backed securities from the government-sponsored enterprises, which assisted in lowering mortgage rates and support the housing market.

Reference

Plosser, C. I. (2018). The risks of a Fed balance sheet unconstrained by monetary policy. The Structural Foundations of Monetary Policy, 1-16.

Question 2

Price bubble is the sustained rise in the price of an asset above its normal market value price bubbles are created by the future expectation of the planned increase in the price of specific assets. While price bubble result to increase of the price, the future hope of improved value of the asset may not be attained (Vasilenko, 2018). Some of the things that result in price bubble include low-interest rates leading to an increased number of people taking cheap credits as such spend more, resulting in increased demand for the products. Reduced supply or future expectation of reduction of supply of the asset resulting in increased demand. Price asset bubble can lead to inflation if the banks do not handle the issue well. On the other hand, market expectation can lead in credit bubble whereby there is an expansion of credit which are not backed by the anticipation of future profit but the expectation of future credit. In this case, there is a lot of credit available to investors

Reference

Vasilenko, A. (2018). Should Central Banks Prick Asset Price Bubbles? An Analysis Based on a Financial Accelerator Model with an Agent-Based Financial Market. An Analysis Based on a Financial Accelerator Model with an Agent-Based Financial Market (June 30, 2018). Bank of Russia, (35).