expansionary monetary policy involves the Federal Reserve injecting money into t

Question

expansionary monetary policy involves the Federal Reserve injecting money into the economy so the banking system can make more loans and thus increase the money supply even more. The Federal Reserve injected a huge amount of money into the economy in response to the U.S. recession of 2008-09, but banks did not increase their loans very much, so the money supply did not increase by nearly as much as the Federal Reserve wanted. Why do you think that banks were so reluctant to increase their loaning activity? Write a short paragraph explaining your reasons for why banks were so reluctant to increase their lending activity in response to the Fed’s actions. Your discussion should be specific, utilize examples and demonstrate an understanding of the use of monetary policy.

Explanation / Answer

There are many reasons banks wont transfer the interest rates literally from central bank directly to consumers. Some of them are as follows

1. If Banks change their base rates, all the existing loans rates should also be changed. At the time of initiation of a loan, Bank would have borrowed at a higher rate, so now after rates have come down, bank cannot transfer rates decrease because they have to maintain a weighted average gain on the loans.

2. 2008-09 recession was mainly because of mortgage loans bust. Obviously banks have increased their loan disbursement criteria and started lending more carefully, so avoid any bankrupcy by borrowers. Because of this additional criteria, numbers of loans in the market have been decreased.

Please let me know if you need more explanations on these points. Thanks.

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