a) The purpose of establishing the asset purchase program was to help the European Union members create growth within their economies, but as time passed the member economies still looked weak and low chances of growth. The Governing Council, therefore, decided to expand the program to assist in boosting confidence, increasing inflation and driving down the value of the Euro to help in growing exports by the region
b) Sovereign bonds are financial debt instruments issued by a national government within a country and are denominated in either a local or foreign currency. Asset Backed Securities, on the other hand, are notes or bonds issued by institutions, backed by their financial assets such as auto loans. The income payments and the value of the ABS are therefore derived from the pool of these assets. Covered bonds are debt securities that are backed by cash flows from public sector loans and or mortgages; they are similar to asset-backed securities with the only difference being they remain on the balance sheet of the firm issuing them. or until inflation rate reaches a target of 2%
c) The expanded purchase program will last until 2016 September because the ECB is planning on spending € 1.1 trillion during the period to September 2016 in installments of € 60 billion a month. This is aimed at encouraging investing activities in the euro zone which will, in turn, lead to economic growth. Setting a target inflation will inform the euro zone governments to align their monetary policy in a manner that can help achieve this target. This will encourage banks to be able to provide medium to long-term loans and hence encourage spending and mostly invest in the region. It will also help in increasing exports as the value of the euro will be lowered.
a) The 2008 financial bailout was a historical precedent because the US government guaranteed mergers and acquisitions of private banking institutions and in some cases offering financial support to banking institutions that made these acquisitions. These resulted in what is referred to as "too big to fail". The government also offered financial support to some non-American banks allowing them to sell their debts to other banks. The Fed was also selective in the institutions they bailed out allowing Lehman Brothers to collapse but previously supporting the acquisition of Bear sterns by J. P Morgan Chase.
b) As much as CMOs were losing value the Federal Reserve needed to boost liquidity in the country and thereby increase confidence in the market as the bank would be able to offer credit allowing businesses to take loans for their operations. The CMOs were held by financial institutions which as a result of not being able to sell these instruments were facing liquidity problems.
c) The United States government raised funds for the bailing out of these financial institutions and other firms in 2008 by borrowing money from the capital markets through treasury bonds and bills which had short term, medium term and long term maturities. Some of these instruments were in the form of IOU'S. The treasury also printed enough money to increase spending but not to result in inflation.
a) The Chinese government pegs the Yuan to the dollar at a fixed rate to ensure that their exports are cheap since the US Dollar is the commonly used currency for trading in the world. The US is also the largest market in the world and, therefore, finds their goods more affordable. This results to a boost in Chinese products and therefore ensuring economic growth for the country. A fixed currency will also allow Chinese companies to pay their dollar-denominated bonds without the risk of defaulting.
b) The world uses the dollar as the common currency for international trading. China has pegged its currency to the dollar. If the dollar strengthens against other currencies so does the Yuan. These means that their exports become more expensive as compared to other countries that are also net exporters. They, therefore, lose market share and demand for their products.
c) Investment capital is flowing out of china as a result of the weakening Yuan which is resulting to lower returns on investments relative to other currencies. As the US Dollar strengthens to other currencies the Yuan which is pegged to it also strengthens. This result in a decrease in returns generated from Chinese assets relative to their currencies, investors are looking for other markets that offer high returns.
d) Foreign exchange reserves are currency assets held by a central bank. The most common currency held is the US Dollar while others commonly held are the Euro, the Yen and the Sterling Pound. The reserves are held to assist in foreign exchange trade.
e) A country can be net importers or net exporters. Since the US Dollar is the most commonly used currency for trade, most net exporters prefer their currencies to be weaker so as to result in more earnings for their exports. To ensure stabilities in their economies countries hold reserves so as to be able to support their currencies in case demand rises or drops. In short reserves allow governments to mop up liquidity in the market.
f) Chinese companies with dollar-denominated bonds will default if the Yuan devalues because the interest on these loans will become expensive to pay back. The Chinese companies generate revenues in Yuan will be required to spend more Yuan to buy dollars when paying back their debt. These will affect cash flows and companies may, therefore, be unable to run their operations hence, end up defaulting on their debts.
a) The Fed uses open market operations as they are more effective than directly changing lending rates and reserve requirements and they have a less permanent and faster to implement. The Fed uses open market operations as it does not result in speculation and hence large flight of capital from the financial markets and also from banking institutions. This, therefore, ensures that the systems stability is maintained and those investing in the economy can do so without fear of loss of investments and financial liquidity.
b) Open market operations involve the sales and purchase of financial instruments issued by the US Treasury and Federal agencies by the Federal Reserve Bank resulting in a decrease or increase in the reserve accounts of the banking institutions. The funds are deposited or withdrawn directly from the reserve accounts of the banks. Raising or lowering discount rates has a more long-term effect on the economy. If discount rates are raised banks with loans may face challenges in funding their daily activities. Commercial banks will also issue expensive loans and raise rates of loans present in the banks. This will, therefore, result in a drop in money supply in the economy. A decrease in the discount rate will have an inverse impact as compared to an increase in the rates. Raising reserve requirements for deposit-taking institutions will result in a change in the lending policy of banks. Banks will be forced to lend less to individuals, institutions and also each other resulting in a drop of money supply in the economy in the short run. It will, on the other hand, reduce the risk that depositors are exposed to thereby ensuring stability in the system. Decreasing reserve requirements will have the opposite impact in both the short and long run
a) The US government carries out a survey referred to as The Current Population Survey (CPS) every month to measure how many people are unemployed in the country. The survey is performed by the United States Census Bureau on behalf of the Bureau of Labor Statistics. A sample population of sixty thousand (60,000) eligible households - translating to nearly 110,000 people - are interviewed in person or over telephones. The interviewee nor the interviewer does not determine whether the interviewee is employed or unemployed. This is determined by how they answer the set of Discussions asked about their recent activities.
b) The employment rate is determined just in the same way as the unemployment rate. A sample group from 800 different geographical areas that represent all industrial fields in the country is interviewed using a specific set of Discussions. How they respond to this Discussions determine if they are employed or not. The ratio of those employed in the 110,000 individuals is then calculated in form as a percentage and then compared to the total employable workforce in the country.
c) I believe Ms. Yellen should not change the current level of interest rates until the end of 2016 due to the economic slowdown in other economies. The drop in unemployment in the US is a good sign as to the strengthening of the Country's economy and is a result of the present monetary policies. Due to the strengthening of the economy, the Fed should maintain these and, therefore, watch how the slowdown in other major world economies is affecting growth in the country. The Chairperson should then make a decision based on the data available.
a) To raise reserves I would: Borrow from other banks as it is a cheaper source of funds compared to borrowing from the Federal Reserve through the discount window. I would also consider liquidating some assets especially the risky ones as it is an easy way to raise funds and provide cash for the bank. Increasing interest rates offered for deposits placed with the bank. This will, in turn, attract funds from institutions and hence can be used to bolster the reserve requirements. Another option will be calling back loans provided to customers. If customers pay back their loans then the bank will have some funds to increase the reserves. Finally, I could improve reserves by raising capital, by either taking debt from the capital markets or through selling the banks shares.
b) The impact of the above decisions will be dependent on the size of my bank, the larger the bank the more its impact will be felt in the system. The main effect of the above strategies will be reducing money supply in the economy. Offering high interest on deposits will result in a lot of capital movements and also an increase in interest on loans. As a result of low money supply, the Federal Reserve Bank may in turn decrease the interest rates that is if it aims to increase the money supply in the system. Expensive deposits will result to lower profits for banks.