Fed Balance Sheet 3000000 Fed Agency Debt Mortgage-Backed Securities Purch Liquidity to Key Credit Markets 2500000 Lending to Financial Institutions Long Term Treasury Purchases Traditional Security Holdings 2000000 Millions 1500000 1000000 500000 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Source: Cleveland Fed a) (10 points) We discussed the concepts of sterilization and unlimited balance sheet capacity. On the graphic above, locate (mark on the graphic) the period of sterilization and explain exactly what sterilization is and why and under what conditions, central banks practice sterilization. Why was the Fed practicing sterilization during this period and what exactly was the concern about this sterilized intervention? (more room next page) YOU CAN ANSWER THIS b) (10 points) The Fed pleaded with Congress to push up the date in which the Fed would be granted the authority to pay interest on reserves. Why was the Fed pleading for this authority, when did they get the authority, and what did they do as soon as they got the authority? Please mark on your diagram the date that the Fed received this authority. Finish your essay by answering the following questions: What exactly does 'unlimited balance sheet capacity' mean? What happened to excess reserves and the money multiplier as soon as the Fed was granted the authority to pay interest on reserves? Please use an expression for the money multiplier to support your answer. YOU CAN ANSWER THISa) (10 points) Fill in the blank below. If you want maximum 'bite' in your forward guidance then you sho have put a on it The authors of this paper argue that the FED could have done better in their forward guidance. Write an essay explaining how forward guidance is supposed to work in terms of influencing the economy and what the Fed should have done differently and why (according to the authors). Use the two graphics (below) to support your answer. That is, mark the period where the Fed achieved maximum 'bite' on their forward guidance as 'maximum bite' on both diagrams identifying the date and what the Fed did exactly to achieve this 'maximum bite.' 10-Year Treasury 5 Year Treasury 5 2-Year Treasury 1-Year Treasury -Federal Funds Rate 3 3 2 2 1 2008 Jan-200> Jul-2007 Jan-2008 Jan-2009 Jui-2009 Jan-2010 Jul-2010 Jul-2011 an-2012 ul-2012 Jan-2013 ul-201 Jan-2014 Jul-2014 JuI-2 Jan-4 3.5 3 - 1.5 M 05- 0 0.5 2002 2004 2006 2008 2010 2012 2014 write your answer for part a) here YOU CAN ANSWER THIS b) (10 points) Now explain how we can use the diagrams to identify the period of maximum bite. That is, on the first graph, how exactly can we tell, by viewing the graph, the period of maximum bite. Be sure to comment on the similarities or differences in the movement of the various interest rates before the period of maximum bite as well as during the period of maximum bite. YOU CAN ANSWER THIS c) (5 points) Similarly, using the second graphic, how can we identify the period of maximum bite in the Fed's forward guidance? Be sure to comment on what exactly the vertical axis represents in the second graph and how we should interpret it before the period of maximum bite as well as during the period of maximum bite. YOU CAN ANSWER THIS d)(10 points) We have been discussing all semester about when and if the Fed is going to get off the zero bound and start raising interest rates (aka, the exit strategy). Write an essay discussing how the Fed plans to mise short term interest rates. Note that the traditional policy of conducting open market operations to influence reserve supply and influence the federal funds rate definitely does not apply in the current 10 context. Why? So explain exactly how the Fed plans on raising short term interest rates using two of their relatively new tools. Please explain the intuition as to how these tools are supposed to work YOU CAN ANSWER THIS