Question

During the global financial crisis, how was the Fed able to help offset the sharp increase in financial frictions without the option of lowering interest rates further? Did the Fed’s plan work?

Short answer

he Fed dropped the fed funds rate to zero to offset or mitigate the effects of the global financial crisis by increasing aggregate demand in the economy.

The Fed's actions were insufficient and unable to properly stabilise the economy's economic activity.

Step-by-step solution

Step 1. Introduction

Financial crises occur when a money-related resource loses a significant portion of its nominal value all of a sudden.

Step 2. Explanation

The Fed dropped the fed funds rate to zero to offset or mitigate the effects of the global financial crisis by increasing aggregate demand in the economy. However, this approach proved insufficient to keep the economy's aggregate demand stable. As a result, the Fed turned to unconventional monetary policy and began purchasing assets, which helped to lower medium and long-term interest rates while also increasing aggregate demand. Because the severity of the crisis was so great, the Fed's actions were insufficient and unable to properly stabilise the economy's economic activity.