by Dave Coker

Created on: June 20, 2008

A question has been raised about The Fed's ability to fix the current state of our economy. Specifically, it has been asked can The Fed's "new tools" suffice to resolve the problems underlying our economy.

This paper will argue that yes, The Fed will indeed be able to overcome our current problems. As part of this argument, we will first identify what problems have arisen and what problems The Fed has focused its attention on. We will next outline tools already at the disposal of The Fed and briefly illustrate their functioning. Next, we will identify new tools that have been deployed and describe their use.

Finally, we will outline the scale of the problems presently facing The United States and illustrate why the new tools - when used together with existing tools - will help The Fed fix our economy.

CURRENT PROBLEMS FACING THE UNITED STATES

The current malaise regarding the performance of our economy seems to have had its origins in the ongoing housing crisis which began Q3 of 2007.

The housing crisis is the aftermath of a speculative bubble focused on real estate in The United States. Much like the so-called "dot com" speculative bubble which saw unrealistic share values, prices for real estate diverged markedly from fair value. Initiated by low interest rates and encouraged by a light regulatory environment, unsound lending practices took hold and flourished, fueled on by the greed of participants at all levels. The bubble grew and grew but as it did The Federal Reserve raised interest rates multiple times over a three year period, from a 2003 low of 1% to a 2006 high of 5.25%, in an attempt to bring it back under control.

It is a fact that asset bubbles never slowly deflate, rather they burst and sometimes the fallout is widespread.

Amid the backdrop of a bursting housing bubble, additional questions about the state of our economy have been raised by sharp increases in commodity prices at the same time the US Dollar has plunged and economic growth in America - as well as most of the G7 - slows. Others symptoms include rapid inflationary increases at the same time credit lines being offered by banks to the public are being sharply decreased or withdrawn totally.

The Fed has identified the sub-prime crisis and the withdrawal or reduction of banking credit lines as their number one problems at this time.

All things considered, it is easy to see why the mood of the nation is sour. But the United States has experienced similar problems in the past. Not precisely

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