The Federal Reserve in Crisis

Abstract

approached near panic in their adoption of multiple and inconsistent traditional policy measures and, since December 2007, they have multiplied these efforts by adopting major new policy tools, some of which may go well beyond their congressional mandate. These actions have been motivated, in the first instance, by an emerging mortgage foreclosure crisis that began in late-2006 and that the Fed first recognized in May 2007, in the second instance by a credit crisis that emerged in August in Europe and quickly moved on shore. This article summarizes and explains the Fed actions since last August. Normal policy actions The Fed conducts monetary policy primarily through setting a federal funds rate target and a primary credit rate (formerly called the discount rate). The federal funds rate is the rate at which depository institutions (banks) borrow or lend funds held in their deposit accounts at the Fed. This rate is agreed between borrower and lender institutions on individual loan transactions, generally overnight. The Fed attempts to intervene in Treasury security market through open market operations, which are the purchase or sale of Treasury securities with primary security dealers, in order to change the amount o