Econ 2035 exam 3

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Before the financial crisis of 2007-​2009, what were the monetary policy tools that the Fed relied​ on?

discount policy, reserve requirements, open market operations

If this assumption were incorrect​, then the central bank would be able to control the money supply through changes in the monetary base __________________ changes in the money multiplier.

and

The Fed was initially tasked to​ ________. Since that​ time, the responsibilities of the Fed have​ ________.

provide​ short-run liquidity to​ banks, oversee the banking​ system, and manage the money​ supply; expanded greatly

Michael​ McAvoy's explanation of how the Federal Reserve Bank cities were selected is more consistent with a​ _______ of how the decision was made since he finds that locations were determined based on​ _______.

public interest​ view; sound economic reasons

Economic​ well-being is typically determined by the

quantity and quality of goods and services that individuals can enjoy.

Why did the United States have no central bank between 1836 and​ 1913?

the authorization for a central bank expired

The behavior of which three groups is included in the money supply​ process?

the banking system, the federal reserve, the nonbank public

What are agency residential and commercial​ mortgage-backed securities​ (MBS)?

Securities that are issued by​ government-sponsored enterprises​ (GSEs) such as Fannie Mae and Freddie Mac

In what ways does the​ Fed's purchases of Treasury securities and​ mortgage-backed securities lead to​ "smooth market​ functioning"?

Sellers of these securities can find buyers and​ can, therefore, continue to fund their operations.

What are the arguments for a Federal Reserve Bank operating​ independently?

A regional Federal Reserve Bank acting independently can act quickly to address regional issues.

What are the arguments against a Federal Reserve Bank operating​ independently?

A regional Federal Reserve​ Bank's actions might exacerbate a crisis. A regional Federal Reserve Bank would be circumventing the checks and balances built into the system.

What is the public interest view of the​ Fed's motivation?

A theory of central bank decision making that holds that officials act in the best interests of the public.

At what interest rate does the demand curve for reserves become perfectly​ elastic?

At the interest rate the Fed pays on​ banks' reserve balances.

What are repurchase​ agreements?

A​ short-term loan backed by collateral such as U.S. Treasury notes

Which groups would likely benefit from​ deflation? Which groups would likely be​ hurt? _______ would likely gain from deflation and ______ would likely lose

Creditors; borowers

When examining the​ Fed's balance​ sheet, in most​ periods, the two most important liabilities ​are:

Currency in circulation and Reserve balances of banks.

Would deflation create some of the same problems as inflation in terms of the information communicated by price changes and the arbitrary redistribution of​ income?

Deflation, just like​ inflation, complicates the ability to distinguish overall price changes from relative price​ changes, which determine resource allocation. Unanticipated deflation redistributes income just as unanticipated inflation​ does, but from borrowers to lenders rather than from lenders to borrowers.

do open market operations ​imply?

The purchase or sale of securities, typically U.S. Treasury securities, in financial markets

Which of the following is not one of the three categories of discount​ loans?

emergency credit

The need for open market operations is determined by _____________ while the execution of the open market operation is conducted by ______________

federal open market committee the federal reserve bank of New York

If the currency−to−deposit ratio (C/D) decreases​, the money multiplier will

increase

A reduction in the reserve ratio would _____________ the money multiplier. A reduction in currency in circulation would __________ bank reserves. Both of these factors would ____________ the money​ multiplier, __________ the money supply while the monetary base __________

increase; increase; increase; increasing; remained the same

The Fed​ doesn't seek to reduce the unemployment rate to zero because the tools of monetary policy are

ineffective in reducing the level of frictional unemployment.

If the Fed uses these two new monetary policy tools to manage the federal funds​ rate, it can lower its target rate by​ _______.

lowering the interest rate it pays on overnight reverse repurchase facilities decreasing the interest rate it pays on​ banks' excess reserves

What is the relationship between the federal funds rate and the interest rates on​ 30-year mortgages and on Aaa and Baa rated corporate​ bonds? These rates generally​ ________.

move​ together, although the federal funds rate often increases and decreases more than these​ long-term rates.

Deflation would be​ "potentially highly​ damaging" because of all of the following​ EXCEPT?

It would make prices​ fall, so goods would become less expensive.

Why do fluctuations in interest rates make investment decisions by households and firms more​ difficult?

Because the cost of borrowing becomes more uncertain.

Why does the supply curve have a horizontal​ segment?

Because the discount rate sets a ceiling on the federal funds rate.

Was Fed Chairman Bernanke justified in evading the requirements of this act during the financial crisis of​ 2007-2009?

Because the financial crisis was unfolding so​ quickly, one could argue that Bernanke was justified in evading the Sunshine Act.

Explain whether you agree with the following​ observation: "Since March​ 2020, the required reserve ratio has been equal to​ 0, therefore any increase in the monetary base can lead to an infinite increase in the money​ supply.

Disagree. If the required reserve ratio equaled​ zero, the simple deposit multiplier would equal​ infinity, implying that multiple deposit expansion would go on forever.​ However, the realistic money​ multiplier, which includes currency and excess reserve​ holdings, would not equal infinity even if the required reserve ratio equaled zero.

Why would the​ Fed's buying Treasury securities and​ mortgage-backed securities keep​ "financial market conditions​ easy"?

It increases bank​ reserves, resulting in lower interest​ rates, making it easier to borrow and spend in the economy.

Is it easier for a central bank to be independent in a​ high-income country or in a​ low-income country?

It is often difficult for a central bank to act independently in a​ low-income country.

What is the simple deposit​ multiplier?

It is the ratio of the amount of deposits created by banks to the amount of new reserves.

When economists speak of the​ "zero lower bound​ problem" that the Fed sometimes​ faces, what are they referring​ to?

It is when​ short-term interest rates are close to​ zero, meaning the Fed can no longer use changes in interest rates to stimulate the economy.

What was the effect on banks of the fed's decisions to increase the required reserve ratio

It reinforced monetary contraction and it lowered the money multiplier

What is the likeliest explanation for why the arrival in Argentina of the​ Covid-19 pandemic resulted in an increase in the​ country's monetary​ base?

Its central bank was likely purchasing large amounts of government​ securities, causing its balance sheet to expand.

What is the main problem with having a central bank that is not independent of the rest of the​ government?

Less independent central banks tend to lead to higher inflation. An independent central bank can more freely focus on keeping inflation low.

]Which of the following is NOT a supportive argument that the​ Fed's dual mandate should be replaced with a single mandate of price​ stability?

Monetary policy can sometimes be used to stimulate the economy quickly in times of large decreases in demand which can reduce unemployment in the economy.

What are the main arguments for the​ Fed's independence?

Monetary policy is too important to be left to​ politicians, who are not economists and have their own political interests at stake. An independent Fed makes a political business cycle less likely.

As of March​ 2020, the Fed no longer required banks to hold required reserves. Did that change mean that after March​ 2020, the monetary base consisted only of currency in​ M1?

No, banks still hold​ reserves, especially large banks that need to satisfy the Basel accord requirements.

Do the funds the Fed uses to buy Treasury bonds represent​ "new money"? If​ not, how does the money supply increase as a result of the Fed buying Treasury​ bonds?

No, the money supply grows as a result of the money multiplying process through continual deposits and loans.

In the modern​ Fed, would it be possible for a Reserve Bank to act as the New York Fed did in​ 1929?

No. In the modern Fed a Reserve Bank cannot conduct monetary policy independent from the FOMC and the Board of Governors.

This statement shows the FOMC using a monetary policy tool. Briefly explain which monetary policy tool it was. (too long)

Open market​ operations, since the Fed plans to keep buying securities to keep the federal funds rate at its target rate.

What are the new tools the Fed has used in recent years when facing the zero lower bound​ problem? ​

Purchasing​ long-term securities—quantitative easing Providing insight on future Fed policies—forward guidance

Which of the following might be a reason to explain the difficultly in identifying inflated asset​ prices?

Reasonable investors can have widely varying expectations of future profitability.

What implications does your answer have for what the average inflation rate is likely to be in​ high-income countries as opposed to​ low-income countries?

Research has shown that the more independent a central bank​ is, the lower the inflation rate will be.​ Thus, one would expect the average inflation rate in​ less-developed countries to be higher than in industrial countries.

Why did Congress set up a system that had this tension between the Reserve Banks and the Federal Reserve​ Board? ​

Tension was created to ensure that various interests would have input into the conduct of monetary policy. Your answer is correct. This was all part of the organizational plan to prevent one faction of the banking system from having too much power.

In what sense is the Federal Reserve System both accountable to the government and independent of​ it?

The Board of Governors is a federal government​ agency, while the Federal Reserve Banks are legally the equivalent of private corporations.

Which body is more important within the Federal Reserve​ System, the Board of Governors or the Federal Open Market​ Committee?

The Board of Governors since they control reserve​ requirements, the discount​ rate, and hold a majority of the seats on the Federal Open Market Committee.

In what ways is the Fed subject to external​ pressure?

The Congress can amend the​ Fed's charter and powers or even abolish it entirely. The president can exercise control over the membership of the Board of Governors and appoint a new chairman every four years.

Why is the process of the multiple expansion of deposits so important to understanding how the banking system​ operates?

The Fed can accurately control the monetary​ base, however, the Fed does not control the actions of the other particpants in the money supply process which is greatly affected by the banking system. Banks play a large role in the economy as a major source of lending to most borrowers. Since banks make so many​ loans, the effects from these create additional impacts in the banking system. Because the monetary system operates under a​ fractional-reserve banking​ system, banks can create money on their own through the deposit creation process.

If the Fed wishes to contract the total value of checkable deposits in the banking​ system, what action can it​ take?

The Fed can sell Treasury bills to financial institutions.

Why does the Fed set the discount rate higher than the federal funds​ rate?

The Fed sets the discount rate higher because it wants to be considered the lender of last resort.

Prior to​ 2007, the​ Fed's securities purchases were primarily​ short-term Treasury​ securities, such as​ T-bills. Why did the Fed begin purchasing​ mortgage-backed securities?

The Fed wanted to push down the interest rate on mortgages to make it easier for people to buy houses.

What is the purpose of the Government in the Sunshine​ Act?

The Government in the Sunshine​ Act, which required government agencies to post meetings before they​ happened, was created to promote public awareness.

The same publication refers to​ "the banking​ system's ability to multiply loans and deposits with the individual​ bank's inability to do​ so." Which of the following is NOT a reason the banking system is able to multiply loans and deposits when an individual bank is unable to do​ so?

The banking system is directly controlled by the Fed.​ Therefore, the amount of lending and deposits are directly determined by Fed policy.

Has the tension been resolved in the modern​ Fed?

The board has much more power​ today, but the tension remains.

If the banks were holding excess reserves for reasons of safety, why might the Fed's staff have been overestimating potential monetary and credit expansion?

The fed assumed that banks would loan out these excess reserves

Why does the Fed charge different interest rates on the three categories of discount​ loans?

The interest rates are based on the level of risk associated with the banks seeking funds.

A Federal Reserve publication notes that when economists analyze the money supply​ process, they typically assume that the money multiplier is​ "independent of the policy actions of the central​ bank." Briefly explain what this assumption​ means?

The money multiplier is determined by a variety of factors over which the central bank has no control.

A theory of central bank decision making that holds that officials act in the best interests of the public.

The political business cycle would be more likely with the​ principal-agent view where the Fed lowers interest rates to stimulate the economy before an election to avoid conflict with groups that could limit its power and influence.

What are the main arguments against the​ Fed's independence?

The public is unable to hold Fed officials accountable for their​ policies, unlike elected officials. It would be more democratic for elected officials to control monetary policy.

If you owned a firm that did business​ internationally, why would excess fluctuations in the foreign exchange value of the dollar make planning for business and financial transactions more​ difficult? ​

They make it difficult to know the dollar value of foreign assets. They make it difficult to know the cost of imported intermediate goods. They make it difficult to know the cost of your products abroad.

Why might banks in the​ mid-1930s have been holding reserves for​ "reasons of​ safety"?

They were holding reserves to guard against bank runs.

Gary Richardson of the University of​ California, Irvine observed in a Federal Reserve publication​ that, "The flaws in the Federal​ Reserve's structure became apparent during the initial years of the Great​ Depression." What is he referring to with this​ statement?

The​ Fed's power was initially too​ decentralized, spread across 12​ districts, to respond effectively to a national crisis.

Why does the​ Fed's purchase of Treasury bills lead to​ "multiple deposit​ creation"?

The​ Fed's purchase of Treasury bills increases the amount of reserves at banks.

Explain the effect on the demand for reserves or the supply of reserves of the following Fed policy​ action: An increase in the interest rate paid on reserves.

This would raise the interest rate at which the demand curve becomes horizontal.

What are the reasons banks demand​ reserves?

To hold excess reserves to meet their​ short-term liquidity needs. To meet their legal obligation to hold required reserves.

If there is a conflict of interest in the governance structure of the Federal Reserve​ Banks, why did Congress establish this structure when it passed the Federal Reserve Act in​ 1913?

To prevent one constituency from exploiting the central​ bank's economic power at the expense of another constituency.

An article on marketwatch.com in​ mid-2020 observed:​ "Growth in the balance sheet has been slowing as the Fed has tapered the pace of its asset​ purchases." What types of asset purchases is the article referring​ to? The article is referring to the​ Fed's purchases of​ ________.

US treasury securities

What does the editorial mean by​ "pricing and allocating​ capital"? In what way does buying corporate bonds involve a central bank in pricing and allocating​ capital?

When a central bank buys​ bonds, it increases the demand for​ bonds, causing bond prices to rise and their interest rates to drop.

When Congress gave the Fed a dual mandate, why did they choose these two monetary policy goals?

When the Fed achieves these two policy​ goals, it usually also leads to achieving its other goals.

Thomas​ Hoenig, former president of the Federal Reserve Bank of Kansas​ City, remarked about the Federal Reserve System​ that: "​[I]t was designed as a​ public-private partnership, accountable​ to, and yet independent​ of, the government." Part 2 In what sense is the Federal Reserve System a "​public-private partnership"​?

While authorized by the​ government, it is owned by private banks.

An opinion column on​ barrons.com, discussing the conflict between President Trump and Fed Chair Jerome​ Powell, observed:​ "Leave aside the arguments over policy for a moment. Consider instead the Constitutional question of an unelected agency of government officials working to thwart the policies of elected​ officials." Is it correct to describe the Fed as​ "an unelected agency of government​ officials"?

Yes, it is true that Fed officials are not​ elected, so in some sense the quote is correct.

why did Congress decide to establish the Federal Reserve System in 1913?

a panic and economic recession in 1907

what is a principal-agent view

a theory of central banking that holds that officials maximize their personal well-being rather than that of the general public

What is the aim of monetary​ policy?

advance the economic​ well-being of the​ country's citizens.

Why would the Fed slowing the rate at which it is purchasing these assets result in the growth of the monetary base​ slowing? When the Fed purchases these​ assets, it causes​ ________. This means that if the Fed stops buying these​ assets, the growth rate of the monetary base would slow.

bank reserves and currency in circulation to increase

Who are the Class A​ directors?

bankers

why was the federal reserve system split into 12 districts

because there was opposition in Congress to establishing a​ single, unified central bank.

An open market operation is when the Fed ________________. The Fed engages in open market operations in order to _____________

buy or sells securities in financial markets influence bank reserves and short-term interest rates

Why does Congress directly control fiscal policy—the federal​ government's decisions with respect to spending and taxes—but delegate the authority over monetary policy to the Federal​ Reserve?

congress wanted the federal reserve to operate independently of external political pressures

the federal reserve seeks to reduce

cyclical unemployment

As the federal funds rate decreases​, the opportunity cost to banks of holding excess reserves _______________ because the return they could earn from lending out those reserves _______________

decrease; go down

It would be ________ for the Fed to have a set policy of deflating asset bubbles when it being so ______ to determine whether asset prices are inflated above their fundamental value or not

hard; hard

In an interview in July​ 2020, during the​ Covid-19 pandemic, Federal Reserve Bank of Dallas President Robert Kaplan​ stated: "I just​ don't want to pull out one objective . . . pulling out inflation . . . without regard to other​ considerations, and without regard to the second part of the dual​ mandate." What was Kaplan referring to as the​ "second part of the dual​ mandate"?

high employment

Which of the​ Fed's traditional monetary policy tools was the most​ important?

open market operations

what does seltzer mean by "potential monetary and credit expansion"?

referring to the multiple deposit creation process

Why would buying corporate bonds expose a central bank to more political pressure than would buying bonds issued by a​ government? Buying bonds in a particular industry​ ________ that industry and can lead to politicians​ ________.

supports; asking central banks to buy bonds in industries they support

Currency is a liability to the Fed rather than an​ asset, even though currency is considered​ vauable, because:

the Fed is responsible for maintaining the value of currency and a holder of currency could exchange it at the Fed.

The term​ "extraordinary easing​ measures" refers to

the Fed using all possible methods to engage in quantative easing.

How does the monetary base differ from the money​ supply? You must multiply the monetary base by _________________ to find the size of the money supply. For the Fed to be able to control the money supply by controlling the monetary​ base, ___________________

the money multiplier; the money multiplier must be stable

Evaluate the​ economist's statement. The economist is thinking that​ ________.

the president may want the Fed to lower interest rates during​ elections, but the Fed will focus on the​ long-term health of the economy.

What potential conflicts of interest is this document referring​ to? A Federal Reserve document states​ that: "due to concerns about potential conflicts of interest ... Class A directors may not participate in most aspects of the appointment process of Reserve Bank presidents and first vice presidents."

the supervision of member banks

The supply of reserves is determined by

the​ Fed's provision of​ non-borrowed reserves through open market operations. borrowed reserves in the form of discount loans from the Fed.

Why would these asset purchases cause the​ Fed's balance sheet to​ rise? The size of the​ Fed's balance sheet is usually based on the value of the​ Fed's

total assets

​"Extraordinary easing​ measures" would end deflation by greatly ________ aggregate demand and thus pushing prices ____________

upward; increasing

In​ general, what do economists mean by a ​"principal-agent ​problem"? By a ​"principal-agent ​problem," economists mean​ ________.

when the goals and priorities of those in charge do not match the goals and priorities of the people they oversee

Given that inflation erodes the value of​ money, should the Federal Reserve pursue a goal of deflation​?

​No, deflation encourages consumers to delay​ consumption, which can cause the economy to contract.

Did the​ Fed's asset purchases also cause the monetary base to​ rise?

​Yes, because the asset purchases would have increased reserves or currency in circulation.


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