Econ 2035 chapter 15
What was the approximate peak amount of borrowing from the Fed during the Financial Crisis of 2007-2009?
$1 trillion
One of the extraordinary policy actions taken by the Fed in response to the financial crisis of 2007-2009 was making huge asset purchases. These asset purchases greatly increased all of the following
Bank reserves, the size of the Feds balance sheet, the monetary base
All of the following are associated with rising inflation
Income redistribution, firms hesitating to enter into long-term contracts with suppliers, families having trouble deciding how much to save for retirement
What statement accurately describes the Fed's control of discount policy?
It controls discount policy less completely than it controls open market operations
What new policy tools for controlling reserve balances did the Fed introduce during the Financial Crisis of 2007-2009?
The Fed began to pay interest on reserves. By paying a higher interest rate, it can encourage banks to maintain their reserve holdings. The Fed initiated reverse repurchase agreements, where it sells a security to a financial firm while at the same time promising to buy the security back the next day. By raising the interest rates it is willing to pay on these loans, the Fed reduces the willingness of its counterparties to lend at a lower rate. The term deposit facility gives the Fed another tool in managing bank reserve holdings. The more funds banks place in term deposits, the less they will have available to expand loans and the money supply.
How many times has the Fed changed reserve requirements since 1993?
never
If the Fed wished to decrease the money supply, it could
raise the interest rate it pays on reserves
Depository institutions such as savings and loans have deposits with the Fed that ________, and financial institutions such as Fannie Mae have deposits with the fed that ________.
receive interest; do not receive interest
In the federal funds market diagram, an open market sale by the Fed
shifts the reserve supply curve to the left
When did the Fed first begin to use open market operations as a policy tool?
the 1920s
Reserve requirements are set by
the Fed
What was the goal of Operation Twist?
to reduce long-term interest rates and increase short-term interest rates
The Open Market Trading Desk is
linked electronically to a group of private securities firms that the Fed has selected to participate in open market operations.
Inflation is an economic problem because it
makes prices less useful as signals for resource allocation
Which types of unemployment still occur even when the economy is considered to be operating at full employment?
At full employment, there will still be frictional and structural unemployment.
Which central bank has its exchange rate as a focus of its monetary policy?
Bank of Canada
Under which chair did the Fed implement the policy of inflation targeting?
Bernanke
What is the difference between defensive and dynamic open market operations?
Dynamic open market operations are intended to change monetary policy as directed by the FOMC. Defensive open market operations are intended to offset temporary fluctuations in the demand or supply for reserves, not to carry out changes in monetary policy.
What statements are true?
Each Federal Reserve Bank maintains its own discount window, before 1980, the Fed rarely made loans to banks which were not members of the Federal Reserve System, since 1980, all depository institutions have had access to the discount window.
According to the Taylor rule, what should the federal funds rate target be if inflation is 5%, the target rate of inflation is 2%, the equilibrium real federal funds rate is 2%, full-employment real GDP is $9 trillion, and current real GDP is $8.55 trillion?
Fed funds rate target = 5% + 2% + (1/2)(3%) + (1/2)(-5%) = 6%.
The Fed ended QE3 in
October 2014
What describes the relationship between the actual federal funds rate and that suggested by Taylor's rule following the recovery from the 2001 recession?
The federal funds rate was below that suggested by Taylor's rule
In the United States from 1981 to 1983, the money supply ________ and the inflation rate ________.
increased; decreased
An open market purchase
increases the monetary base
An open market purchase
increases the price of Treasury securities and decreases their yield
The ECB has emphasized what type of goal for monetary policy?
inflation targeting
The Fed's inability to instantaneously observe changes in inflation and economic growth result in
information lag
Traditionally, Fed policymakers have been ________ to use higher interest rates to head off potential asset bubbles ________.
hesitant; because it may cause a slowdown in the economy
Rates of inflation in the hundreds or thousands of percent per year are known as
hyperinflation
In 2016, the Bank of Japan
instituted a negative interest rate on deposits it receives from Japanese banks, effectively requiring banks to pay the Bank of Japan for keeping their deposits
During the financial crisis, the Fed introduced three new policy tools connected with bank reserve accounts. What are those three tools?
interest on reserve balances, overnight reserve repurchase agreement facility, term deposit facility
Most economists believe that a zero rate of unemployment
is inconsistent with a well-functioning economy
The Fed's goal of interest rate stability
is motivated by political pressure as well as by a desire for a stable saving and investment environment
All of the following arguments are presented in favor of inflation targeting
it would draw attention to what the central bank can achieve in practice, it would provide an anchor for inflationary expectations, it would promote accountability by providing a yardstick by which policy can be measured
All of the following arguments are made against inflation targeting
rigid numerical targets would diminish the flexibility of monetary policy, the Fed would need to depend on future forecasts of inflation since monetary policy acts with a lag, holding the Fed accountable for low inflation may make it difficult for elected officials to monitor whether the Fed is supporting good overall economic policy
As a result of an open market purchase, bank reserves
rise and interest rates fall
Temporary, short-term discount loans to banks in areas in which agriculture and tourism are important are known as
seasonal credit
The unemployment that is caused by changes in the economy, such as shifts in manufacturing techniques, increased use of computers and electronic machines, and increases in the production of services instead of goods, is called
structural unemployment
In addition to the Fed, which other central bank pursued unusual monetary policy following the financial crisis of 2007-2009?
the European Central Bank, the Bank of Japan, and the Bank of England
All of the following central banks took action to stimulate their economies following the 2007-2009 financial crisis and recession by implementing negative interest rates
the European Central Bank, the Swiss National Bank and Denmark's National Bank
Increases in interest rates are often blamed on
the Fed
The Fed uses operating targets as well as intermediate targets because
the Fed controls intermediate targets only indirectly
A falling dollar makes U.S. goods
less expensive abroad and increases the volume of U.S. exports
The policy directive from the FOMC is carried out by
the account manager at the Federal Reserve Bank of New York
The benchmark default-free interest rate of the financial system is generally considered to be
the interest rate on the 10-year Treasury note
The discount window is
the means by which the Fed makes discount loans to banks
By the time of the annual monetary policy conference in Jackson Hole, Wyoming in 2016,
the monetary base and the Fed's balance sheet remained very large, and the target for the federal funds rate had only slightly risen
Primary credit is only a backup source of funds for healthy banks since
the primary credit rate is set above the federal funds rate
All of the following statements about secondary credit are true
the secondary credit interest rate is set above the primary credit rate, it is intended for banks not eligible for primary credit, borrowers of secondary credit are less financially healthy
Since 1980, discount loans have been available
to all depository institutions
What are accurate descriptions of open market operations prior to 2008?
It was used to affect the market for bank reserves, it was used to control the federal funds rate, it involved buying and selling short-term Treasury securities
On which type of unemployment can monetary policy have the most effect? Why?
Monetary policy has the most effect on cyclical unemployment by stimulating the economy when its in a recession.
Under which circumstance is the Fed most likely to carry out a defensive open market operation?
if a snowstorm results in a delay in check clearing, resulting in an increase in the Federal Reserve float
Expansionary monetary policy consists of all of the following
lower interest rates, increased monetary base, increased money supply
Interest rate fluctuations
make it difficult for households and firms to plan for the future
A rising dollar makes U.S. goods
more expensive abroad and decreases the volume of U.S. exports
The Fed can implement open market operations
more rapidly than either changes in the discount rate or changes in reserve requirements
The third round of quantitative easing, announced in September 2012, was focused on purchases of
mortgage-backed securities
How did Operation Twist affect the monetary base?
no change
Discount loans intended for banks that are NOT financially healthy are called
secondary credit
In a matched sale-purchase transaction, the Fed
sells securities to a dealer and the dealer agrees to sell them back
In the federal funds market diagram, a decrease in the required reserve ratio
shifts the demand curve for reserves to the left
Sally Jones lost her job at a steel company because of a permanent decline in the demand for steel. Sally Jones is considered by economists to be
structurally unemployed
Which of the Fed's three new policy tools connected with bank reserve accounts is the least important?
term deposit facility
The bursting of the dot-com bubble contributed to the
recession of 2001
The bursting of the housing bubble was a key factor in causing the severity of the
recession of 2001
When financial markets and institutions are NOT efficient in matching savers and borrowers
resources are lost
A matched sale-purchase transaction is also known as a
reverse repo
In December 2008, the FOMC cut its target for the federal funds rate from 1% to a range from 0% to 0.25%, and it remained at this level for
7 years
What is a matched sale-purchase transaction (also known as a reverse repo)?
A matched sale-purchase transaction is when the Fed sells securities to primary dealers, and the dealers agree to sell them back to the Fed in the near future.
What statement about the natural rate of unemployment is correct?
Currently, most economists think that the natural rate is about 5%
How did the federal funds rate compare to that suggested by Taylor's rule following the 2001 recession and during the Financial Crisis of 2007-2009? How would proponents of Taylor's rule evaluate monetary policy in each period.
Following the recession of 2001, the federal funds rate was consistently below that suggested by Taylor's rule. This indicates that monetary policy was too loose and, according to some economists, may have contributed to the housing bubble. During the Financial Crisis of 2007-2009, Taylor's rule suggested that the federal funds rate should be negative, indicating that the Fed should maintain a very low rate and perhaps engage in quantitative easing (since the federal funds rate cannot be negative).
What country experienced hyperinflation during the 1920s?
Germany
What best describes a policy of inflation targeting?
It allows monetary policy to focus on inflation and inflation forecasts except in the case of severe recession.
What accurately describes the Fed's inflation target?
It seeks to maintain an average inflation rate of 2% per year
What is an intermediate target?
M2
What statement is correct?
Open market purchases are expansionary and open market sales are contractionary
What was the name of the plan, enacted in 2011, in which the Fed bought $400 billion worth of long-term securities while selling $400 billion worth of short-term securities?
Operation Twist
According to Taylor's rule, all of the following variables help explain the behavior of the federal funds rate
Output gap, current inflation, inflation gap
What is quantitative easing? What was the Fed's objective in implementing quantitative easing?
Quantitative easing is a policy when a central bank attempts to stimulate the economy by buying long-term securities. The Fed's objective was to reduce the interest rates on mortgages and on 10-year Treasury notes. Lower interest rates on mortgages could help to spur new home sales. And lower interest rates on 10-year Treasury notes could help to lower interest rates on corporate bonds, thereby increasing investment spending on physical capital.
What has been the approach of the European Central Bank to monetary targeting?
The European Central Bank has emphasized the importance of price stability, defined as an inflation range from 0% to 2%.
What is meant by inflation targeting? Does the Fed engage in inflation targeting?
Under inflation targeting a central bank commits to conduct policy to satisfy a publicly announced inflation target within a given time frame. In 2012, the Fed adopted an inflation target.
Describe the temporary lending facilities that the Fed set up during the Financial Crisis of 2007-2009.
Under the primary dealer credit facility, primary dealers could borrow overnight using mortgage-backed securities as collateral. Under the term securities lending facility, the Fed would loan up to $200 billion of Treasury securities in exchange for mortgage-backed securities. Under the commercial paper funding facility, the Fed purchased three-month commercial paper issued by nonfinancial corporations. Under Term Asset-Backed Securities Loan facility, the Federal Reserve Bank of New York extended three-year or five-year loans to help investors fund the purchase of asset-backed securities.
When is the Fed likely to return to to using normal monetary policy procedures?
While the Fed may eventually return to normal monetary policy procedures, it is unlikely to do so in the near future
The Fed's monetary policy tools
have allowed the Fed to achieve its monetary policy goals indirectly
The Fed was created
after financial panics in the late 1800s and early 1900s
A Federal Reserve repurchase agreement involves
an agreement by a dealer to buy back securities she has sold to the Fed
If the account manager does NOT use a Federal Reserve reverse repurchase agreement or a matched sale-purchase transaction in carrying out open market operations, he will use
an outright purchase or sale
Dynamic open market operations
are aimed at achieving changes in monetary policy
Open market operations
are more flexible than other traditional policy tools
Defensive open market transactions
are used to offset disturbances to the supply or demand for reserves
In 2006, the Bank of Japan
began to scale back its expansionary policy, only to return to an expansionary policy following the financial crisis
What interest rates tends to fluctuate the most?
federal funds rate
Intermediate targets are
financial variables, such as interest rates or monetary aggregates, the Fed believes will help it to achieve policy goals
A consequence of the impact lag is that the Fed
might not be able to correct a mistaken policy soon enough
Because of the breakdown in the relationship between the growth of the money supply and inflation, since 1993, the Fed
no longer announces targets for M1 or M2
What is an operating target?
non borrowed reserves
The information lag facing the Fed is
the delay in receiving accurate information about the state of the economy
The inflation gap can best be described as
the difference between inflation and its target
An important problem facing the Fed is that
the goals for economic growth and price stability may conflict in the short run
The output gap can best be described as
the percentage difference between real GDP and its potential
The impact lag facing the Fed is
the time required for monetary policy changes to affect output, employment, and prices
The Fed has attempted to solve the problems of being unable to directly control the variables that determine economic performance and the timing lags in observing and reacting to economic fluctuations by
using targets to meet its goals
In 2016, savings rates in Japan, Germany, Denmark, Sweden, and Switzerland
were at their highest level since 1995, indicating that negative interest rates were not increasing consumer spending
When the Fed raised its target for the federal funds rate in 2015, it set the interest rate it pays on overnight reverse repurchase agreements at
0.25%
When the Fed raised its target for the federal funds rate in 2015, it set the interest rate it pays on excess reserves at
0.50%
What are the goals of monetary policy?
High employment, economic growth, price stability
What is an accurate description of the steps by which the FOMC causes the actual federal funds rate to rise into its target range when it votes to raise the federal funds rate target?
IOER is increased → this affects depository institutions that can borrow and lend in the federal funds market AND are paid interest on their deposits with the Fed → this pushes the federal funds rate to the top of the target range → federal funds rate rises into this new range.
How does the interest paid on reserves set a floor for the federal funds rate?
If the federal funds rate was lower than the interest on reserves, banks could borrow from one another at a low rate and earn a risk-free return on reserves. Competition between banks to carry out the risk-free arbitrage would force the federal funds rate up to the interest rate on reserves.
What statement concerning seasonal credit is TRUE?
Improvements in credit markets have reduced the need for a seasonal credit facility
What is an accurate description of the steps by which the FOMC causes the actual federal funds rate to rise into its target range when it votes to raise the federal funds rate target?
ON RRP is increased → this affects certain nonbank financial institutions that can borrow and lend in the federal funds market BUT ARE NOT paid interest on their deposits with the Fed → this keeps the federal funds rate above the bottom of the target range → federal funds rate rises into this new range.
Suppose banks incur heavy losses and become more cautious, increasing their demand for reserve. Make use of a graph of the federal funds market to show how the Fed can use open market operations to maintain the same federal funds rate.
The Fed will conduct open market purchases, increasing the supply of reserves (shifting it to the right) by a sufficient amount to ensure that the federal funds rate remains at its current rate.
Suppose the current federal funds rate is 0.25% and the Fed chooses to raise its target to 0.5%. Make use of a graph of the federal funds market to show how it will use open market operations to accomplish this.
The Fed will conduct open market sales, reducing the supply of reserves (shifting it to the left) until the new equilibrium federal funds rate rises to 0.5%.
What statement is correct?
The discount rate is generally above the federal funds rate
Describe the three types of unemployment
The three types of unemployment are frictional, structural, and cyclical. Frictional unemployment occurs when some people move into and out of the job market or when people are between jobs. Structural unemployment refers to unemployment resulting from changes in the structure of the economy. Cyclical unemployment is unemployment associated with recessions.
What statement is correct?
The volume of defensive open market operations is much greater than the volume of dynamic open market operations
What statement is correct?
The volume of open market operations is determined solely by the Fed
How were open market operations conducted prior to 1935?
They were carried out by the district Federal Reserve banks
The FOMC states its overall objectives for interest rates in
a policy directive
If the account manager finds that the current level of bank reserves is greater than the desired level indicated in the most recent directive from the FOMC, he will
conduct an open market sale
In order to increase its target for the federal funds rate, the Fed would normally
conduct open market sales
An open market sale
decreases the price of Treasury securities and increases their yield
The original Federal Reserve Act
did not specifically mention open market operations
John Smith leaves his job in New York to go to California in hopes of finding a better one. If John Smith is unemployed while searching for a job in California, economists would consider him to be
frictionally unemployed
The Fed tends not to use discount policy as its principal tool in influencing the money supply since
it does not have as much control over discount loans as it has on open market operations
If the Fed desired to reduce the federal funds rate
it would conduct an open market purchase, increasing reserve supply
Reserve requirements are changed
less frequently than open market operations are conducted and less frequently than the discount rate is changed
Congress established the FOMC because
of a lack of coordination among district banks in carrying out open market operations
High employment spurs economic growth because high employment
often leads to high rates of investment
How does the Open Market Trading Desk conduct its operations?
over-the-counter electronically with private securities dealers
How can the Fed reduce the implicit tax on banks resulting from reserve requirements?
paying interest on reserves
Primary dealers are those
permitted to trade directly with the Fed
When economists and policymakers refer to the Fed's dual mandate, they are referring to
price stability and maximum employment
Discount loans available to healthy banks which can be used for any purpose are called
primary credit
The Employment Act of 1946 codified the federal government's commitment to
promote high employment consistent with price stability
During and after the financial crisis of 2007-2009, the Fed greatly increased the supply of reserves through three rounds of quantitative easing by
purchases of both long-term Treasury securities and mortgage-backed securities
When all workers who want jobs have them and the demand for and supply of labor are in equilibrium
unemployment is at its natural rateWhich of the following statements about the natural rate of unemployment is correct?
The assumption that reserves are scarce
was accurate prior to the financial crisis of 2007-2009 but not following the crisis.
