Macroeconomics

Introduction
Key points:
The Federal Reserve, U.S. central bank had make their decision to continue on with buying treasury and mortgage bonds with the new money through the policy of quantitative easing. They chose not to taper because the unemployment rate has reduced. Moreover, according to the federal census, the real household incomes in America did not fall any further. Hence, quantitative easing has been quite good for increasing employment and boosting the household wealth in US (The Economist, 2013).
Justification of Topic:
This topic is chosen because it shows how the US Central Bank deal with their recession by using quantitative easing, which is closely related to monetary policy and how it affects the aggregate demand and aggregate supply. By using
Economic Analysis:
Monetary Policy: Objectives and Framework
Central bank is a national bank that controls the quantity of money and banking services for its country’s government and commercial banks. Their responsibility is to stabilize currency, control inflation and maximize employment. (Investopedia, 2009) To achieve these goals, central banks uses three main policy tools, which is liquidity reserves ratio, open market operations government securities and also last resort loans.
Monetary Policy: Expansionary Monetary Policy
Fed uses expansionary monetary policy like quantitative easing to curb recession. Quantitative easing is a monetary policy whereby a Central Bank injects more money into the economy by purchasing government or mortgages bonds with the new money that they have created (Economics Online, 2013). Open Market Operations (OMO) is the purchase or sale of government securities by the central bank from or to a commercial bank or the public. Hence, when Fed runs out of options, they will use quantitative easing to boost the economy by increasing money supply into the market (politics.co.uk, 2012).
When Fed buys more bonds through quantitative easing, it injects more money into the economy, decreases the interest rates and causes the investments output to increase. Based on the figure 1, when Fed injects more money to the economy and interest rates is reduced from r0 to r1, a shortage will occur. So in order to maintain the interest rates as low as possible and overcome the shortage, Fed will buy bonds in the open market operation to increase money supply and this is going increase the bank excess reserves.
Based on figure 2, when the money supply increases, the money supply curve will shift from MS0 to MS1. However, if the money supply shifts to MS1, a surplus will occur when the interest is still at r0. When there is surplus, the banks have excess liquidity to buy bonds. Buying bonds will increase the money demanded for speculation, which causes point A to go down to point B. This will cause the interest rate to fall from r0 to r1. In order to maintain a low interest, Fed has to increase money supply, which can be seen at figure 2 where the money demand is equal to the money supply at the equilibrium point, point B.
Since there is more money in the market and the interest rates are lowered, more money will be lend out and cost of borrowing will decrease as well, which helps stimulate spending since it is easier to borrow money. This can be seen in Figure 3 where investment increases from I0 to I1 and this will eventually increase the Real GDP demanded.
Aggregate Demand and Aggregate Supply
Aggregate demand is the total quantity of final goods and services produced domestically that business, government, consumers and foreigners plan to buy at a period of time. This quantity is the sum of AD=C+I+G+NX. Aggregate supply curve is the relationship between quantity of real GDP supplied and the price level. The aggregate supply the amount of real GDP supplied which is the total quantity of goods and services that firms plan to produce during a given period (Investopedia, 2009).
Since people can purchase more comfortably, this will cause a greater demand for goods and services. When investment increases, this will cause aggregate demand to increase as well. Hence, the increase of consumption and investment will cause the aggregate demand to increase. Based on figure 2, the aggregate demand curve to shift to the right from AD1 to AD2. However, there is a shortage at P0, but because price is flexible, the shortage will be curbed. The shortage is curbed when point A moves to point B and point C moves to point B when there is increase in price which indicates the increase of revenue that causes the aggregate supply to increase as well. Therefore, economy moves from point A to B where the recession is curbed and the economy settles to full employment at point B.
One of the main reasons the Fed chose not to taper and continue on with the quantitative easing because unemployment rate has reduced from 8.1% to 7.3% (The Economist, 2013). Quantitative easing helps in increasing employment because aggregate demand and output are proportional. Hence, if AD increases, the output increases as well and this will require more labour work causing the demand for labour to increase (Ukessays.com, 2013). This will increase employment rate.
Moreover, it helps to boost household wealth and increases the disposable income. Quantitative easing can increase income because workers can expect a raise when the economy is doing better. Since the economy is doing better and there is an increase in business expansion, there will be higher paying jobs. (Milliken, 2013). Therefore, the Fed wants to continue on with quantitative easing as it is increasing employment rate and boosting the household income.
Conclusion & Suggestion:
In conclusion, the Fed managed to achieve their objectives through quantitative easing. However, quantitative easing is very risky and it may be ineffective after some time. The drawback of quantitative easing is inflation may occur because of the increase in money supply and the value of US dollar to drop. Hence, the Fed needs to implement quantitative easing carefully with other policies to avoid severe side effects, as these long-term impacts will be very high. Fed may use policy mix like using fiscal policy to affect the market’s goods rather than just reducing the interest rate. Therefore, the Fed needs to make sure that these policies do not remain for too long and end the policy once they’ve reached their target of unemployment rate, which is 7%.

Appendix

FIGURE 3

FIGURE 4

References
Economics Online (2013) Quantitative easing. Available from: http://www.economicsonline.co.uk/Global_economics/Quantitative_easing.html [Accessed: 21 Oct 2013].
Investopedia (2009) Central Bank Definition | Investopedia. Available from: http://www.investopedia.com/terms/c/centralbank.asp [Accessed: 21 Oct 2013].
Investopedia (2009) Aggregate Supply & Aggregate Demand - CFA Level 1 | Investopedia. Available from: http://www.investopedia.com/exam-guide/cfa-level-1/macroeconomics/aggregate-supply-demand.asp [Accessed: 21 Oct 2013].
Milliken, F. (2013) Lexington Libertarian: Spelling It Out: Income Inequality Caused By Quantitative Easing. Available from: http://lexingtonlibertarian.blogspot.com/2013/09/spellin-it-out-income-equality-casued.html [Accessed: 21 Oct 2013]. politics.co.uk (2012) Quantitative easing. Available from: http://www.politics.co.uk/reference/quantitative-easing [Accessed: 21 Oct 2013].
The Economist (2013) Taper tiger. Available from: http://www.economist.com/news/finance-and-economics/21586562-federal-reserve-surprises-everyone-changing-nothing-taper-tiger [Accessed: 21 Oct 2013].
Ukessays.com (2013) Quantitative Easing In The United States Economics Essay. Available from: http://www.ukessays.com/essays/economics/quantitative-easing-in-the-united-states-economics-essay.php [Accessed: 21 Oct 2013].

References: Economics Online (2013) Quantitative easing. Available from: http://www.economicsonline.co.uk/Global_economics/Quantitative_easing.html [Accessed: 21 Oct 2013]. Investopedia (2009) Central Bank Definition | Investopedia. Available from: http://www.investopedia.com/terms/c/centralbank.asp [Accessed: 21 Oct 2013]. Investopedia (2009) Aggregate Supply & Aggregate Demand - CFA Level 1 | Investopedia. Available from: http://www.investopedia.com/exam-guide/cfa-level-1/macroeconomics/aggregate-supply-demand.asp [Accessed: 21 Oct 2013]. Milliken, F. (2013) Lexington Libertarian: Spelling It Out: Income Inequality Caused By Quantitative Easing. Available from: http://lexingtonlibertarian.blogspot.com/2013/09/spellin-it-out-income-equality-casued.html [Accessed: 21 Oct 2013]. politics.co.uk (2012) Quantitative easing. Available from: http://www.politics.co.uk/reference/quantitative-easing [Accessed: 21 Oct 2013]. The Economist (2013) Taper tiger. Available from: http://www.economist.com/news/finance-and-economics/21586562-federal-reserve-surprises-everyone-changing-nothing-taper-tiger [Accessed: 21 Oct 2013]. Ukessays.com (2013) Quantitative Easing In The United States Economics Essay. Available from: http://www.ukessays.com/essays/economics/quantitative-easing-in-the-united-states-economics-essay.php [Accessed: 21 Oct 2013].