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Monetary Policy and the Recent Extraordinary Measures Taken by the Federal Reserve



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Monetary Policy and the Recent Extraordinary Measures Taken by the Federal Reserve Testimony before the Committee on Financial Services U S House of Representatives John B Taylor Professor of Economics Senior Fellow Hoover Institution Stanford University February 26 2009 Thank you Chairman Frank Ranking Member Bachus and other members of the House Committee on Financial Services for inviting me to testify on monetary policy and the extraordinary measures taken by the Federal Reserve over the past 18 months The best way to begin examining these extraordinary measures is to look at the extraordinary increase in reserve balances at the Fed shown in Figure 1 Reserve Billions of dollars 2 400 Implied future reserve path if used to finance MBS 437B TALF 200B Treasury CBLI 800B with no other offsets 2 000 1 600 1 200 800 Actual reserve path 400 9 11 0 00 01 02 03 04 05 06 07 08 09 Figure 1 Reserve Balances The solid line shows the actual movements and the dashed line shows the implied future movements balances or deposits at the Fed are the key component along with currency of base money or central bank money which the Federal Reserve is responsible for controlling and which ultimately brings about changes in the broader money supply measures The sharp increase in reserve balances began in mid September 2008 For the week ending September 10 banks and 1 other depository institutions held 8 billion in reserve balances at the Fed By the week ending December 31 2008 they held 848 billion The Fed had increased the supply of reserve balances by 100 fold in a very short period of time Note also how large this increase is compared with the then extraordinary increase around the time of 9 11 and the physical damage to the financial markets The recent increase came about as a direct result of the Fed s decision to purchase securities and make loans to certain sectors and financial institutions More specifically the Fed financed these securities purchases and loans by creating



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