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Then and Now - Evolving Fed Response to the Financial Crisis

Brent Holt
Assistant Professor, Economics
Ivy Tech Community College
Indianapolis, Indiana
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This material is replicated on a number of sites as part of the SERC Pedagogic Service Project

Summary

Students will first play the Fed Chairman game (online simulation) adjusting the Federal Funds Rate and targeting desirable unemployment rates using one of the traditional traditional tools of Fed policy to achieve the goals of growth with price stability and employment. After playing the game, students will read a presentation from the SanFrancisco Federal Reserve Bank CEO outlining new Fed policy with the consideration that manipulating the federal funds rate is no longer an option in the foreseeable future. How can the Fed effectively stimulate the economy without its most visible and effective policy lever? Play the following Fed Chair Game simulation, and read the recent presentation from the San Francisco Federal Reserve Bank CEO in order to gain insight into traditional policy, and newer policy responses given current economic conditions.

Learning Goals

Students will be able to identify the changes necessitated in Fed policy because of the immediate required response to the Financial Crisis of 2008. Students will learn the evolution of Fed responses resulting from these conditions. Additionally, students will gain increased awareness of the increasing monetary inflows and outflows to the fed, and their effects on the financial composition and operations of the Fed. Further, students should gain insight into how the assets and liabilities to Fed operations have changed, and how the Fed's management of these influences the overall picture, and which policy measures are more or less expansive or restrictive.

Context for Use

This activity is appropriate for Economics Fundamentals or Macroeconomics courses for either on campus or online classes in the 15-40 student range. Students will be required to perform the initial phase of the activity outside of normal class activities (online). This activity will be used as a supplemental phase to the traditional functions and policy levers used by the Fed.

Description and Teaching Materials

Part 1:

First, students should play the "Fed Chair Game" Simulation link .

Play at least two full rounds of the game, and then answer the following questions:

1) Briefly describe how the game shows the use of monetary policy by the Fed.

2) Describe the realtionship between unemployment and inflation while playing the game.

3) What were your strategies in playing the game? How did you react to either unemployment or inflation increasing?

4) Describe the effects of unforeseen events on the economy during the game. How do these events impact the Fed's actions?

5) Given your experiences with the game, what do you believe to be the most important function of the Fed? What kinds of problems might the Fed encounter in carrying out these policies?

6) Did you get reappointed? Why or why not?

Part 2:

Economic growth has continued slowly since the Financial Crisis. The Fed has maintained a policy of keeping the Federal Funds rate low through this period, which limits the ability to further lower rates to stimulate the economy. What has been traditionally known as Open Market Operations has taken an increased prominence in terms of policy inititatives. Please read the following presentation from the CEO of the San Francisco Federal Reserve Bank, and then answer the following questions:

http://www.frbsf.org/economic-research/publications/economic-letter/2012/november/federal-reserve-unconventional-policies/

1) What are the limitations of further manipulations to the Federal Funds Rate? Describe what is meant by the phrase "zero lower bound".

2) What potentially disruptive effects might occur if interest rates were negative?

3) What are some of the similarities and differences between what has traditionally been described as Open Market operations, and the Quantitative Easing, or Large-Scale Asset Purchases (LSAP's)described in the presentation?

4) What is the intention of the LSAP's?

5) Do you believe that the more open, or transparent style of communication between the Fed and commercial markets will lead to increasing or decreasing stability in financial and investment markets? Why or why not?

6) What might be potential drawbacks to an ongoing policy of LSAP's?

Teaching Notes and Tips

Students may need to update or refresh their browsers before accessing the game. Play at least two full rounds of the game.

The playing field is still evolving – links to Fed information, Federal Reserve Bank individual Websites, and press releases are all available to encourage additional student interaction and engagement.

Assessment

Students should be able to clearly identify why the Discount Window and the Federal Funds rate may no longer be sustainably viable as monetary policy levers. Students should have a clear understanding of the evolution of the types of new policy levers and their effects of their inflows and outflows on the Fed's financial status.

References and Resources