Chapter 14: The Federal Reserve and Monetary Policy
The Banking Act of 1999 extended the jurisdiction of the Federal Reserve to include:
- pension funds. - insurance companies. - investment companies.
The liquidity trap says that when interest rates are low:
- people will not put money in the banks. - people will not lend. - people will simply hold money.
A key difference between quantitative easing and conventional monetary policy was
- quantitative easing targeted long-term interest rates. - quantitative easing dealt with mortgage backed securities rather than government bonds. - quantitative easing dealt with asset with maturity dates of greater than one year.
The goals of monetary policy are
- satisfactory economic growth. - relatively full employment. - price stability.
Members of the Federal Reserve Board of Governors:
- serve 14-year terms. - can only serve 1 term. - terms overlap so one new vacancy occurs every two years.
The credit crisis in 2008 was caused by:
- subprime mortgages. - investment firms trying to leverage the real estate market.
Prior to 2008 quantitative easing was used by:
- the Fed in the 1930s. - the Bank of Japan in the 2000s. - the Bank of England in the 2000s.
Faster monetary growth would lead to higher GDP growth because
lower interest rates lead to higher investment.
When the Federal Reserve changes the discount rate and the Federal Funds rate simultaneously it is called
"banging the gong."
A bank has $300 in reserves with a total of $2,000 in deposits, how much more of the reserves can they lend if the reserve requirement was 10%?
$100
A bank has $500 in reserves with a total of $1,000 in deposits, how much of the reserves can they lend if the reserve requirement was 10%?
$400
Of the $700 billion allocated to TARP, _______ was actually dispersed.
$425 billion
In its role as the lender of last resort, on September 12, 2001 the Federal Reserve Bank made ______ worth of loans.
$45.5 billion
The first round on quantitative easing (2009) included:
- $1.25 trillion in mortgage backed securities. - $200 billion in debt from Fannie Mae and Freddie Mac. - $300 billion in long-term government securities.
Members of the Federal Open Market Committee include
- 4 presidents of the district banks (except for New York and Washington DC) on rotating one-year terms - the president of the New York Federal Reserve District Bank - the Board of Governors
The Depository Institutions Deregulation and Monetary Control Act of 1980:
- allowed all depository institutions to issue checkable deposits. - gave all depository institutions all the advantages of the Federal Reserve. - made all depository institutions subject to the Fed's legal reserve requirement.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010:
- allows federal officials to break up firms whose failure would create financial havoc. - created a Consumer Financial Protection Bureau. - ends loose mortgage lending practices.
Members appointed to the Federal Reserve Board of Governors:
- are nominated by the president. - serve 14-year terms. - must be approved by the senate.
Deposit creation is limited by:
- banks need some money to operate. - the Federal Reserve sets legal requirements.
When comparing monetary and fiscal policies:
- both suffer the same type of lags. - there is no general agreement about which is better.
When the economy is in recession, the Federal Reserve can
- buy securities on the open market. - lower the discount rate. - lower the reserve requirement.
Money creation (bank loans) occur when the FOMC:
- creates reserves - buys bonds
The money supply includes
- currency. - checkable deposits.
The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act:
- limits banks so they can only invest 3% of their capital in hedge funds and private equity funds. - ends loose mortgage lending practices.
The Federal Reserve can increase the money supply by:
- lowering the discount rate. - lowering the reserve requirement. - buying government securities.
Subprime borrowers typically:
- paid a low "teaser rate" that would go much higher. - were relatively poor.
Major flaws with the TARP program include:
- the money was not used for its express purpose. - there was no requirement for banks to expand lending. - there was no prohibition that banks use the money to pay bonuses.
The creation of money involves
- the person wishing to borrow money. - the Federal Reserve. - the bank that creates the money.
The current system of check clearing allows the use of an electronic _____ for transition through the system.
- transfer - image
Primary reserves include
- vault cash. - deposits at the Federal Reserve District Bank.
The legal limits for the reserve requirement are
0-25%.
_________ reserves are a bank's deposits at the Federal Reserves District Bank and any vault cash they hold
Blank 1: Primary
A potential policy for the Federal Reserve when the economy is in recession would be to __________ securities on the open market.
Blank 1: buy or purchase
The Federal Reserve tends to change the reserve rate about once a __________.
Blank 1: decade
If a bank is holding more reserves than are required it has ________ reserves.
Blank 1: excess
The Banking Act of 1999 _______ the role of the Federal Reserve.
Blank 1: expanded, increased, strengthened, or extended
The TARP program was mostly used as an ________ policy against a prolonged ________.
Blank 1: insurance Blank 2: recession
The creation and destruction of money is a major function of banking, this is done through ________.
Blank 1: loans
One would expect _________ policy lags to be shorter than ________ policy lags.
Blank 1: monetary Blank 2: fiscal
What open market operations consist of is the buying and selling of the ______ debt.
Blank 1: national
The _______ rate is the rate of interest banks charge their most credit worthy customers.
Blank 1: prime
Ultimately, in order to raise interest rates the Federal Reserve would want to _________ the price of government bonds.
Blank 1: reduce, lower, or decrease
When the FOMC buys bonds, they pay with a check, when the check clears bank __________ increase allowing the bank to make more loans. As banks make loans __________ expansion occurs.
Blank 1: reserves Blank 2: deposit
Conditions in the housing market in the early 2000s, lenders greatly expanded the pool of home buyers by issuing ________ loans to families that could not have otherwise qualified for homeownership.
Blank 1: subprime
True or false: Bit coins are added into the money supply (M1) calculation.
False
The principle decision-making body of the Federal Reserve is the:
Federal Open Market Committee
Banks create money by making loans, the process is controlled by the
Federal Reserve.
The first round of quantitative easing was
about $1.75 trillion and lasted for one year.
When the Federal Reserve pushes up interest rates on government securities,
all interest rates tend to rise.
The president can only "control" the Board of Governors by
appointing members of the board that agree with his policies and occasionally can appoint a significant part of the board.
When the United States established the Federal Reserve system in 1913
banks finally had a lender of last resort to avoid bank panics.
The Federal Reserve is reluctant to tighten monetary policy too much for too long because tight money
causes recessions.
The switch to electronic check clearing means
checks will clear in a day rather than 3 or 4.
When conducting open market operations, the Federal Reserve
deals with older bands that have already been marketed by the Treasury.
The ratio of the change in demand deposits to the change in bank reserves is the
deposit expansion multiplier.
The FOMC's main role is to:
determine monetary policy
The interest rate charged by the Federal Reserve to depository institutions is the
discount rate.
When the Federal Reserve was first created, the interest on loans to banks was taken out before the payment is made (if you borrowed $1,000, you may only get a check for $920), this process was known as
discounting.
The Monetary Control Act of 1980 made the Fed's job of controlling the money supply
easier since they now have control over all banks.
The FOMC meets ______ to determine monetary policy.
eight times per year
The interest rate banks and other depository institutions charge one another on overnight loans made out of excess reserves is the
federal funds rate.
In the past it would be three of four days after you wrote a check before it cleared your account, with electronic check cashing checks can clear
in a day (or less).
One of the traditional jobs of the Federal Reserve is check clearing, this task
is still very costly as it requires the constant moving of paper check across the country.
The Federal Reserve rarely uses the reserve requirement as a policy tool because
it is too powerful.
If a major investment firm like Bear Stearns was to fail:
it would have led to a chain of failures with 100s or 1000s of firms failing
Although there are relatively few loans made by the Federal Reserve, they stand by as the
lender of last resort.
If you have a bond that pays a face rate of 10%, and a face value of $1,000, but you purchased the bond for more than the face value the interest rate is
less than 10%, the higher price of the bond nets you a lower interest rate.
The manipulation of the money supply to achieve price stability, relatively full employment, and a satisfactory growth rate is known as
monetary policy.
The purchase or sale of Treasury securities by the Federal Reserve is known as
open market operations.
As a result of actions taken by the Federal Reserve to fight the financial crisis of 2008, in 2010 banks had
over $1 trillion in excess reserves.
Over the 10 years following the financial crisis banks have paid
over $200 billion in fines and restitution an amount that is much less than the damage they caused.
The interest rate banks charge their most credit worthy borrowers is the
prime rate.
When the Federal Reserve buys bonds in an open market operation, they purchase the bonds
private U.S. securities dealers.
The ultimate goal of an open market purchase by the Federal Reserve is to
push down interest rates
To lower the interest rate on an existing bond you would need to
raise the price of the bond.
When loans are repaid, the money supply will be
reduced, no matter how it is repaid.
Through the recession and early stages of the recovery many bankers were
reluctant to make new loans and borrowers feared taking on new debt.
Printing more currency will cause the money supply to
remain the same.
The minimum amount of vault cash or reserves held at the Federal Reserve District Bank is known as
required reserves.
To increase interest rates, the Federal Reserve would
sell securities to drive the price down.
Lower GDP growth results from lower investment when:
slower monetary growth raises interest rates
Credit rationing makes borrowing difficult as a result
spending declines, slowing inflation.
When the Federal Reserve makes an open market purchase through a bond house,
the Federal Reserve Bank of New York writes a check to the bond house, it is passed on the owners of the bonds who deposit it in their bank.
Effective control of the Federal Reserve District Banks is by
the Federal Reserve Board of Governors.
Regulations that have the effect of limited deposit creation are placed on banks by
the Federal Reserve.
The policy that the Federal Reserve uses as a last resort is
the Reserve Requirement.
When the Federal Reserve buys bonds in an open market operation
the increased demand for government bonds causes their price to rise, lowering interest rates.
Banks must hold deposit on account with the Federal Reserve or in cash within their vaults because of
the legal reserve requirement.
It was hoped that in times of crisis the Federal Reserve would be
the lender of last resort.
If low interest rates cause banks to hold reserves rather than lend them out, the economy is experiencing
the liquidity trap.
The Federal Reserve District Banks are owned by
the member banks in the district.
The legal reserve requirement is
the minimum percentage of checkable deposits a bank must keep on deposit or hold as vault cash.
When the bonds purchased by the FOMC are already owned by the bond house,
the process works the same way as if they were an intermediary.
The deposit expansion multiplier is
the ratio of the change in demand deposits to the change in bank reserves.
Since a board member cannot be reappointed, once confirmed by the Senate
there is no reason to expect they will do the presidents bidding.
The Federal Reserve deals exclusively with government securities, as a result
they directly influence the rate on government bonds, since interest rates tend to move together they can change all rates.
As a fallout of the illegal activities that created the financial crisis
virtually all our nation's largest banks were penalized for their actions.
By 2010 nearly 90% of the money lent through TARP
was repaid.