Because the U.S. economy failed to snap back from a mild recession in 2001, the Fed pushed the federal funds rate down to 1%. What effect did this have on the economy?
When the Fed reduced the federal funds rate to 1%, it kept it at that level for over a year. As a result, a number of side effects occurred, which were not not part of the planned effect. First, it pushed up the demand for housing, and housing prices, since lower mortgage interest rates made it cheaper to buy. This boost from that monetary policy helped fuel the burgeoning house price bubble, pushing house prices well beyond what could be justified by the fundamentals. Also, because interest rates dropped, investors were encouraged to "reach for yield" and one way to do that was to invest in riskier securities which paid higher interest rates. This led to increased demands for such risky assets as "junk" bonds, emerging-market debt, mortgage-backed securities, and others, pushing up their prices and reducing their yields. These factors helped create the Great Recession.
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What will be an ideal response?
The order of the letters along the rows of computer keyboards could be changed to allow users to type faster, but this would inconvenience the vast majority of people who learned to type with the current keyboard layout. The costs of switching to a new
layout make this change unlikely. This is an example of A) path dependency. B) how social influences overwhelm the substitution effect of a price change. C) how the elasticity of demand for typewriters has been affected by externalities. D) how consumers sometimes do not behave rationally.
The evidence from banking crises in other countries indicates that
A) deposit insurance is to blame in each country. B) a government safety net for depositors need not increase moral hazard. C) regulatory forbearance never leads to problems. D) deregulation combined with poor regulatory supervision raises moral hazard incentives.