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Effects of liquidity swaps

1. The world's major central banks, including the U.S. Federal Reserve, European Central Bank, Bank of England and Bank of Japan, conducted a joint policy action on 11/30/11 to inject liquidity into global financial markets. Though the action does not help Europe's debt issues, the liquidity swap arrangements between the central banks make it easier to loan U.S. dollars to their financial institutions.

Using an aggregate supply/demand framework to help your argument, please explain how the action will in theory impact business investment and economic growth in the involved economies?

2. What role should current low interest rates play in consumers' decisions of how much to borrow? Explain.

3.What fiscal policy measures could be enacted to help boost real GDP in 2011? Use a macroeconomic framework (i.e. Aggregate Demand/Aggregate Supply) to show the impact on output and price levels.

Solution Preview

When a central bank experiences a liquidity crisis, it is unable to meet funding obligations and settle all its transactions. This trickles down through the banking system, as all member banks depend on the federal reserve for their currency. A liquidity swap prevents this from happening, and in theory keeps the banking system solvent. This means when someone demands their deposits, the bank and provide them, and when the banks wants to make a loan, it can do that as well. In the aggregate demand/ aggregate ...

Solution Summary

Liquidity injection into global markets and how it impacts business investment and economic growth. Effects of interest rates on consumer borrowing. Measures to increase real GDP.