Mortgage Crisis on Money Supply

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Impact of the Mortgage Crisis on Money Supply in the US
AMESIA HARRIS
FINANCE 364
PROFESSOR CROSS

Impact of the Mortgage Crisis on Money Supply in the US
This paper presents the effects of expansionary monetary policy to macro economic variables in the economy. The United States of America recorded a mortgage crisis since 2007. The financial sector issued out massive amounts of money to individuals to acquire homes. This was in line with government campaigns for equitable housing of US citizens in the United States. This led to an increase in loans offered to citizens to purchase homes, leading to an expansionary monetary policy. Though this strategy brought equity in home ownership, it also brought financial imbalance in the economy as a high number of home owners who had borrowed the money could not afford to pay back the borrowed amounts. It thus became hard for the financial institutions to take back the excess liquidity in the hands of individuals in the society (Borek, 2010). GDP Growth and Money Supply

The increase in money supply in the United States was an expansionary monetary policy in the economy (Blinder, & Zandi, 2010). This led to an increase in the nominal money supply in the economy. In normal circumstances’, an expansionary monetary policy is expected to boost income while at the same time driving interest rates down. Although the increase in money supply in the United States’ economy increased lending, it had the potential of triggering competition in the financial sector, increasing access to loans and eventually leading to an increase in output. Governments employ various expansionary measures including reduction of lending rates, interest rates, and buying back government securities among other expansionary measures. However, in this case, the deregulation of the financial sector as well as below optimum credit methods employed by financial institutions handicapped the effect of expansionary monetary policy in spurring growth.   |  |  |  |  |  |  |  |  | |

r

|  |MS1 |  |MS2 |  |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |  |  |LMo |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |  |  |Change in interest rates |  | |  |  |  |  | |  |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |  |  |  |  |  |  | |  |  |  |Change in money supply |  |Y |  | |R: interest rate, MS: Money supply, LM: Money demand

As indicated in the above figure, the initial move by Federal Reserve to lower discount rates led to an increase in liquidity in financial institutions. This led to increased need in such organization to lend out excess liquidity. Because of this, competition in the financial sector went up in terms of lending. This led to financial institutions focusing on the mortgage market since it is capital intensive. Increased lending to this sector led to a decrease in interest rates which further enticed individuals and organizations to borrow more funds to finance mortgages (Vives, 2006). Ironically, not all the above efforts led to increase in output as indicated above. Financial institutions failed to recover loaned amounts. This led to lack of enough money to finance other productive areas of the economy such as production industries and the service sector among others (Congressional Budget Office, 2010). This eventually led to a decline in economic performance. Because of this, it became even harder for mortgage owners to raise income to offset their debts. This eventually led to negative economic growth in the United States (Braxton, 2009). Inflation and Money Supply

The recent mortgage crisis led to an increase in money supply in America. This money supply was directed to mortgages where low output was recorded. This led to an increase in the money in circulation in the United...
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