Chapter 17 SB

Commercial bank reserves generally _______ the largest liability on the central bank's balance sheet and _______ the most important liability in determining the money supply.

are; are

The three primary assets on a central bank's balance sheet are

securities, foreign exchange reserves, and loans.

The United States has many banks because

historically, many states outlawed bank branching.

The Glass-Steagall Act of 1933

required commercial banks to sell off their investment banking operations.

The Gramm-Leach-Bliley Act

repealed the Glass-Steagall Act's prohibition of mergers between commercial banks and insurance or securities firms.

The Dodd-Frank does all of the following except

repeals the Glass-Steagall Act of 1933.

Consider a situation where banks must keep 10% of deposits as required reserves, banks initially hold no excess reserves, and the amount of cash held by the public is unrelated to deposits. After moving through the whole banking system, a $60,000 open market purchases by the Federal Reserve can eventually create _____ in new money. a. $540,000 b. $60,000 c. $54,000 d. $600,000

$600,000

If the required reserve rate is ten percent and banks do not hold any excess reserves and there are no changes in currency holdings, a $1 million open market purchase by the Fed will result in deposit creation of: a. $9 million b. $90 million c. $10 million d. $900,000

10 million

In a nation with a $20 billion money supply and a monetary base of $4 billion, the money multiplier must equal _____. a. 5 b. 24 c. 80 d. 0.25

5

Vault cash is a. Equal to the total amount of reserves and is an asset of the central bank. b. Not reserves but is a liability of the central bank. c. A part of reserves and an asset of commercial banks. d. Not reserves but is an asset of central banks.

A part of reserves and an asset of commercial banks.

What is the difference between solvency and liquidity for a bank?

A solvent bank has a positive net worth while a bank with liquidity means that the bank has sufficient reserves and immediately marketable assets to meet withdrawal demands.

Which of the following is an action taken by the Federal Reserve after 9/11 that was unprecedented or unseen since the Great Depression?

Acquiring loans and previously-traded securities

Which of the following is true about commercial bank membership in the Federal Reserve System (the Fed)?

All nationally-chartered banks belong to the Fed.

The experience of the Marcos Presidency in the Philippines in 1986 showed: a. The importance of keeping the central bank independent from political pressure. b. Published central bank balance sheets do not always reflect reality. c. Transparency is critical if people are going to trust a central bank. d. All of the answers given are correct.

All of the answers given are correct.

When the Fed makes a discount loan, the impact on the Fed's balance sheet will reflect: a. No change in liabilities but an increase in assets. b. A decrease in assets and liabilities. c. An increase in assets and liabilities. d. An increase in assets and a decrease in liabilities.

An increase in assets and liabilities.

Commercial bank reserves generally _____ the largest liability on the central bank's balance sheet and _____ the most important liability in determining the money supply. a. Are not; are not b. Are; are not c. Are not; are d. Are; are

Are not; are

When the Federal Reserve buys $5 million in U.S. government bonds from Bank Y a. Bank Y alone can now create $5 million more in new money. b. Bank Y must call in $5 million worth of loans as a result. c. Bank Y loses $5 million in reserves and the Fed gains them. d. Bank Y will be more profitable than before, even if it takes no further action.

Bank Y alone can now create $5 million more in new money.

Compare and contrast the structures of bank holding companies, financial holding companies and universal banks.

Bank holding companies Correct typically own several banks. Financial holding companies Correct own banks and other financial intermediaries (such as investment banks and insurance companies). In bank holding companies and financial holding companies Correct, there usually remain legal and regulatory separations among the subsidiaries. Universal banks Correct own a variety of intermediaries (with fewer legal and regulatory separations compared to financial holding companies) as well as non-financial firms.

Explain how a bank run can turn into a bank panic.

Bank runs occur when people fear that their bank has become insolvent Correct. Depositors rush to their bank to withdraw their funds. Depositors at other banks become concerned about their own bank's solvency Correct, so they also hurry to withdraw their funds. Bank runs can turn into system-wide bank panics because customers have a difficult time distinguishing insolvent Correctbanks from solvent Correctones.

For the money supply to change as much as predicted by the simple deposit expansion multiplier when we have a change in reserves, we must assume that a. The more money held in deposits, the less cash held by the public. b. Banks hold no excess reserves. c. All banks engage in open market operations. d. The public holds as much cash as possible.

Banks hold no excess reserves.

If the Fed were to increase the required reserve rate from ten percent to twenty percent, the simple deposit expansion multiplier would: a. Double. b. Increase by 10 percent. c. Decrease by a factor of ten. d. Be half as large as it was before the increase.

Be half as large as it was before the increase.

Bonds issued by the U.S. Treasury would: a. Not be held by the Fed. b. Be held by the Fed as part of its securities. c. Be held by the Fed as part of its foreign exchange reserves. d. Be held by the Fed as part of its loans.

Be held by the Fed as part of its securities.

Why can the central bank affect the size and composition of its balance sheet in ways that private citizens cannot? a. Because the central bank can pay on credit. b. Because the central bank can pay for purchases assets by creating liabilities. c. Because the central bank need not record assets on its balance sheet. d. Because the central bank can double count transactions on its balance sheet.

Because the central bank can pay for purchases assets by creating liabilities.

How did the financial crisis of 2007-2009 affect the size and composition of the balance sheet of the Federal Reserve?

Between December 2007 and December 2009, the assets on the Federal Reserve's balance sheet increase by 2.5 times, mostly in the form of securities. The Fed also broadened the rang of assets held to include riskier instruments such as extraordinary loans to non-banks and long-term securities (including mortgage-backed instruments and Treasury bonds). On the liability side of the balance sheet, the liquidity crisis led to an increase in commercial bank deposits at the Fed as banks held on to excess reserves. At times, the Treasury also in deposits at the Fed to help the Fed limit the increase of bank reserves as its assets rose.

Which of the following is true about publication of the balance sheets for the Federal Reserve and European Central Bank?

Both are published online.

Which of the following is true about publication of the balance sheets for the Federal Reserve and European Central Bank? a. Both are published online. b. The European Central Bank's balance sheet is published more often. c. The Federal Reserve's balance sheet is available online; the European Central Bank's is available only in printed form. d. The Federal Reserve's balance sheet is published more often.

Both are published online.

Which of the following is true about bank reserves? a. Both required reserves and excess reserves are liabilities for the central bank. b. For a single commercial bank, its required reserves plus its reserves on hand equal its excess reserves. c. Banks today are strictly constrained by reserve requirements. d. Today banks hold reserves with the primary goal of ensuring banking system stability.

Both required reserves and excess reserves are liabilities for the central bank.

Which of the following does not describe an action taken by the Federal Reserve since the 1930s?

Causing its balance sheet to shrink to unprecedented proportions

After the financial crisis of 2007-2009, on the balance sheet of the Fed, we see that _____. a. Securities held decreased by more than $1 trillion b. Commercial bank deposits increased to 100 times their old level c. During the crisis the Fed stopped paying interest on bank reserves d. The balance sheet has overall gotten much smaller after the crisis

Commercial bank deposits increased to 100 times their old level

The three major liabilities on a central bank's balance sheet are a. Reserves, securities, and foreign exchange reserves. b. Securities, foreign exchange reserves, and loans. c. Cash in bank vaults, cash held by the public, and securities. d. Currency, the government's account, and reserves.

Currency, the government's account, and reserves.

Each of the following items would appear as assets on the central bank's balance sheet, except: a. Loans. b. Securities. c. Currency. d. Foreign exchange reserves.

Currency.

All else equal, then banks hold more excess reserves an economy's ability to expand deposits _____; when the public holds less cash an economy's ability to expand deposits _____. a. Increases; increases b. Increases; decreases c. Decreases; decreases d. Decreases; increases

Decreases; increases

In the U.S., loans made by Federal Reserve to banks fall in the categories of: a. Discount loans. b. Reserves. c. Discount loans and reserves. d. Discount loans and foreign exchange reserves.

Discount loans.

In the United States foreign exchange reserves are composed of

foreign currency held by the Fed.

Why does the Fed hold foreign currency?

For use in foreign exchange interventions In order to change the market values of various currencies

In the United States foreign exchange reserves are composed of a. American currency held by members of the foreign public. b. American bonds sold to foreign citizens. c. Foreign currency held by the Fed. d. Foreign bonds sold to the American public.

Foreign currency held by the Fed.

The United States foreign exchange reserves are composed of a. Foreign currency held by the Fed. b. American bonds said to foreign citizens. c. American currency held by members of the foreign public. d. Foreign bonds sold to the American public.

Foreign currency held by the Fed.

The monetary base is also known as: a. M1. b. M2. c. High-powered money. d. Free reserves.

High-powered money.

Commercial banks cannot create and destroy the monetary base. The Federal Reserve can create and destroy the monetary base. The non-bank public cannot create and destroy the monetary base.

Identify the correct statements about the ability to create and destroy the monetary base. (Check all that apply.)

The currency-to-deposit ratio a. Has a positive (direct) relationships with money multiplier. b. Equals deposits divided by currency held by the public. c. Implies that cash is more desirable as interest rates fall. d. Implies that the interest rate is the benefit of holding currency.

Implies that cash is more desirable as interest rates fall.

Foreign currency held by the Fed is called _____.

foreign exchange reserves

For short-run monetary policy, central banks today generally focus on _____ due to the volatility of the _____. a. Interest rates; money multiplier b. The money supply; monetary base c. Interest rates; monetary base d. The money supply; money multiplier

Interest rates; money multiplier

When the Federal Reserve buys $200 billion of U.S. Treasury bonds from a commercial bank, on the Fed's balance sheet a. There is no change in its total assets. b. The cash account falls by $200 billion. c. Its assets and liabilities both rise by $200 billion. d. Its liabilities in total rise by $200 billion, while its assets fall by the same amount.

Its assets and liabilities both rise by $200 billion.

Reserves held by commercial banks are a. Assets on the central bank's balance sheet in its role as the government's bank. b. Liabilities on the central bank's balance sheet in its role as the government's bank. c. Assets on the central bank's balance sheet in its role as bankers' bank. d. Liabilities on the central bank's balance sheet in its role as bankers' bank.

Liabilities on the central bank's balance sheet in its role as bankers' bank.

The central bank's monetary base is made up of _____ that are held _____. a. Liabilities; publicly b. Assets; publicly c. Liabilities; privately d. Assets; privately

Liabilities; privately

Explain why financial institutions such as pension funds and insurance companies are not as vulnerable to runs as money market mutual funds and securities dealers.

Like deposit-taking institutions, money market mutual funds and securities dealers have liquid Correct liabilities backing illiquid Correct assets and can suffer from a loss of liquidity Correct similar to a deposit withdrawal from a bank at any time. In contrast, liability holders of pension funds and insurance companies cannot Correct withdraw funds whenever they want. Therefore, even though their assets tend to be illiquid Correct, they are not as vulnerable to runs.

Which of the following is not one of the major liabilities on the central bank's balance sheet?

Loans

Assume that the required reserve rate is ten percent, banks want to hold excess reserves in an amount that equals three percent of deposits, and the public withdraws then percent of every deposit in cash. An open market purchase of $1 million by the Fed will see banking system deposits increase by: a. More than $1 million but less than $10 million. b. Exactly $1 million. c. Less than $1 million. d. More than $10 million but less than $20 million.

More than $1 million but less than $10 million.

During the 2007-2009 financial crisis which of the following became the largest component of assets on the Fed's balance sheet: a. Foreign exchange reserves. b. Loans. c. U.S. Treasury securities. d. Mortgage backed securities.

Mortgage backed securities.

Evaluate the following statements and clarify which is/are NOT true about disclosure of central bank information.

Most central banks provide information less than once a month. Although some central banks have delayed disclosure, to date none has falsified information to the public. Historically, delays in disclosure have little correlation with problems within the central bank.

Consider a $2 billion open market purchase of U.S. Treasury securities by the Federal Reserve. The Banking System's balance sheet will specifically show: a. Only an increase in liabilities of $2 billion. b. Only a decrease in assets of $2 billion. c. No net change in assets or liabilities, only a change in the composition of assets with securities decreasing and reserves increasing by $2 billion respectively. d. No net change in assets or liabilities, only a change in the composition of assets with securities increasing and reserves decreasing by $2 billion respectively.

No net change in assets or liabilities, only a change in the composition of assets with securities decreasing and reserves increasing by $2 billion respectively.

If Bank A sells a $100,000 U.S. Treasury bond to the Fed, Bank A's required reserves will: a. Not change. b. Increase by $100,000. c. Decrease. d. Increase but by less than $100,000.

Not change.

The monetary base can be created and destroyed a. Only by commercial banks. b. By the Federal Reserve, commercial banks, or by the non-bank public. c. By the Federal Reserve or by commercial banks. d. Only by the Federal Reserve.

Only by the Federal Reserve.

The quantity of securities held by the Federal Reserve is controlled through: a. The U.S. Treasury b. The Fed's annual budget c. Open market operations. d. The purchases made by the regional Reserve banks.

Open market operations.

The monetary base is the sum of: a. Reserves and currency in the hands of the public. b. Reserves and M2. c. Currency in the hands of the public and M2. d. Currency in the hands of the public M1.

Reserves and currency in the hands of the public.

On the balance sheet of the Federal Reserve, commercial bank accounts refer to _____ and _____. a. Demand deposits; liabilities b. Reserves; liabilities c. Demand deposits; assets d. Reserves; assets

Reserves; liabilities

The three primary assets on a central bank's balance sheet are a. Currency, foreign exchange reserves, and deposits. b. Cash, stocks, and bonds. c. Securities, currency, and borrowing. d. Securities, foreign exchange reserves, and loans.

Securities, foreign exchange reserves, and loans.

Before the financial crisis of 2007-2009, the Fed controlled the federal funds rate and the availability of money and credit by adjusting its holdings of liquid securities, primarily _____. a. Foreign exchange reserves b. Currency holdings c. Short-term Treasury bills d. Loans

Short-term Treasury bills

What event prompted commercial bank deposits to increase to 100 times their old level?

The 2007-2009 financial crisis

Regulators have traditionally required banks to maintain capital-asset ratios of a certain level to ensure adequate net worth based on the size and composition of the bank's assets on its balance sheet. Why might such capital adequacy requirements not be effective?

The importance of off-balance sheet activities has been increasing and the nature of these activities facilitates a high level of risk taking by banks that is not apparent from the institution's balance sheet.

Harry gets $1000 in currency from his grandfather when he graduates from college. He deposits these funds into his checking account. What is the impact on the monetary base of Harry's deposit? a. The monetary base did not change b. The monetary base increased by $1000 c. The monetary base decreased by $1000 d. The monetary base increases by more than a $1000

The monetary base did not change

In dollar amounts: a. The monetary base is larger than M2 and M1 is less than M2. b. M1 is smaller than the monetary base and M2 is larger than both. c. The monetary base if larger than M1 and M2. d. The monetary base is smaller than M1 and M2 is larger than M1.

The monetary base is smaller than M1 and M2 is larger than M1.

Use your knowledge of the problems associated with asymmetric information to explain why insurance companies often include deductibles as part of their policies.

The presence of deductibles helps to reduce moral hazard. In the case of car insurance, for example, the insured faces a cost associated with an accident and so will likely be more careful when driving.

We can move from that unrealistically simple deposit expansion multiplier to a more realistic one by acknowledging that a. Changes in public cash holdings don't affect reserves. b. The public holds more cash as the amount of deposits rises. c. Banks generally hold no excess reserves. d. The more excess reserves a bank holds, the less safe it is.

The public holds more cash as the amount of deposits rises.

In the absence of limits on the behavior of large intermediaries, how might the perception of institutions being "too-big-to-fail" lead to increased concentration in the banking industry?

The safety net creates moral hazard problems for big banks by encouraging extremely risky behavior. This puts small banks at a competitive disadvantage, driving them out of the market and leading to an increase in concentration

Why has the number of banks in the United States fallen steadily in the past three decades?

There has been a trend toward consolidation in the banking industry.

Which of the following are NOT true about the Federal Reserve Banks? (Check all that apply.)

They are led only by the Board of Governors. They take deposits from the general public. The 2007-2009 financial crisis led some to think the Reserve Banks were too hard on financial intermediaries.

Prior to the Civil War most state banks issued their own banknotes. Which one of the following is not true about these banknotes?

They were usually redeemable in gold.

Statistically, teenage drivers are more likely to have an automobile accident than adult drivers. As a result, insurance companies charge higher insurance premiums for teenage drivers. Suppose one insurance company decided to charge teenagers and adults the same premium based on the average risk of an accident among both groups. Using your knowledge of the problems associated with asymmetric information, explain whether you think this insurance company will be profitable.

This insurance company is unlikely Correct to be profitable because of the problem of adverse selection Correct. The insurance premium based on the average risk of an accident among both teenagers and adults will be higher Correct than the premium for adults alone and lower Correct than the premium for teenagers alone. Therefore, adults Correct will not choose to be insured by this company but teenagers Correct will. The premium charged based on the average risk of teenagers and adults would not Correct be sufficient to cover the claims of a teenage-only Correct pool and so the company would not Correct be profitable.

Suppose that male drivers are more likely to have an automobile accident than female drivers. As a result, insurance companies charge higher insurance premiums for male drivers. Suppose one insurance company decided to charge male drivers and female drivers the same premium based on the average risk of an accident among both groups. Using your knowledge of the problems associated with asymmetric information, explain whether you think this insurance company will be profitable

This insurance company is unlikely Correctto be profitable because of the problem of adverse selection Correct. The insurance premium based on the average risk of an accident among both male and female drivers will be higher Correct than the premium for female drivers alone and lower Correct than the premium for male drivers alone. Therefore, female Correct drivers will not choose to be insured by this company but male Correct drivers will. The premium charged based on the average risk of male and female drivers would not Correct be sufficient to cover the claims of a male-only Correct driver pool and so the company would not Correct be profitable.

Which of the following is not an important reason bank managers keep some excess reserves on hand today? a. To provide funds for day-to-day business b. To ensure bank system stability and soundness c. To insure against unforeseen outflows of funds

To ensure bank system stability and soundness

For the Federal Reserve's balance sheet, the asset listed Securities would include: a. Private and public debt. b. Mainly U.S. Treasury and municipal bonds. c. Bonds issued by commercial banks. d. U.S. Treasury securities.

U.S. Treasury securities.

Deflation is the rate of decline in the aggregate price level. Why might unexpected deflation be of particular concern to someone managing a bank?

Unexpected deflation is associated with falling Correct net worth of borrowers, as the nominal value of their assets falls Correct but the dollar amount of their liabilities remains the same Correct. This weakens creditworthiness and can lead to reduced Correct lending as asymmetric information problems worsen. In turn, reduced Correct credit supply can diminish economic activity, leading to increased Correct defaults, a deterioration in the quality of the bank's balance sheet and ultimately to bank insolvency.

The link between the central bank's balance sheet and the money supply is _____ because _____ is too variable. a. Strong; the monetary base b. Weak; the money multiplier c. Strong; the money multiplier d. Weak; the monetary base

Weak; the money multiplier

Which of the following transactions would affect the balance sheets for the Federal Reserve, the banking system, and the non-bank public? a. Federal Reserve purchases of foreign government bonds. b. Open market operations where the Federal Reserve sells securities to a bank. c. Bank borrowing from the Federal Reserve. d. Withdrawal of cash from an ATM.

Withdrawal of cash from an ATM.

Which of the following is true about disclosure of central bank information? a. Most central banks provide information less than once a month. b. Without timely disclosure, there is no way to know if policymakers are doing their jobs. c. Historically, delays in disclosure have little correlation with problems within their central banks. d. Although some central banks have delayed disclosure, to date none has falsified information to the public.

Without timely disclosure, there is no way to know if policymakers are doing their jobs.

In the aftermath of the financial crisis of 2007-2009, there were calls to reinstate the separation of commercial and investment banking activities that were removed with the repeal of the Glass-Steagall Act, but this did not happen. Is there any benefit to segmenting financial activities if the goal is to lower systemic risk?

Yes. This type of separation may serve to remove some conflicts of interest for banks across their different activities and may protect against excessive risk taking with depositors' funds

When the Federal Reserve sells $100 billion of government securities to a commercial bank, the banking system's balance sheet experiences

a $100 billion decrease in reserves.

Vault cash is

a liability that is part of reserves.

The Financial Crisis of 2007-08 occurred in three distinct phases which, in the order of occurrence, are

a liquidity crisis, a solvency crisis, and a recapitalization of the system.

The financial system is inherently more unstable than most other industries due to the fact that

a single firm failing in banking can bring down the entire system unlike in most other industries.

Discount loans are ________ to the Federal Reserve and can be made __________.

an asset; to banks or non-bank institutions in times of crisis

Deflation causes financial disruption when

borrowers have invested in real assets whose value declines while loan payments stay the same.

Identify which of the following are NOT the three major liabilities on a central bank's balance sheet

cash in bank vaults, cash held by the public, and securities. securities, foreign exchange reserves, and loans. reserves, securities, and foreign exchange reserves.

After the financial crisis of 2007-2009, on the balance sheet of the Fed, we see that

commercial bank deposits increased to 100 times their old level.

The three major liabilities on a central bank's balance sheet are

currency, the government's account, and reserves.

Rumors of a bank failing, even if not true, can become a self-fulfilling prophecy because

depositors will rush to the bank to withdraw their deposits and the bank under normal conditions would not have sufficient liquid assets on hand.

Eurodollars are

dollar-denominated deposits in banks outside the United States.

Policy responses were critical in arresting the Financial Crisis of 2007-08 and promoting recovery. The responses used include all of the following except which one?

elimination of interest rate floors

Contagion is the

failure of one bank spreading to other banks through depositors withdrawing of funds.

The Federal Deposit Insurance Corporation (FDIC) was created

in 1933 as a part of the Glass-Steagall Act

During a bank crisis,

it is important for regulators to be able to distinguish insolvent from illiquid banks.

Reserves held by commercial banks are

liabilities on the central bank's balance sheet in its role as bankers' bank.

A central bank's credibility is particularly important when it comes to the goal of ________, because _______________.

low inflation; many economic decisions are based on expectations about future prices

When compared to Canada or Japan, the United States is unusual in that it has

more banks than either Japan or Canada.

In the early years of the Great Depression, 1929-1933,

more than a third of all U.S. banks failed.

During the financial crisis of 2007-2009 in the United States it was revealed that the function of a lender of last resort had not kept pace with the evolving financial system because

shadow banks lacked access to the financial resources available through the lender of last resort.

Ultimately monetary and fiscal policy have

the same ultimate goal but sometimes conflict.

One reason customers do not care about the quality of their bank's assets is that

there is deposit insurance which protects deposits even if the bank fails.