Econ 343 Exam 3

Subtracting borrowed reserves from the monetary base obtains a. reserves. b. high-powered money. c. the nonborrowed monetary base. d. the borrowed monetary base.

c. the nonborrowed monetary base.

Explain two developments in recent years that have led to the decreasing importance of reserve requirements in determining the money multiplier and the money supply

1.ATM's. Banks realize they need to store more cash to service the number of ATM's needed. This is leading to more excess reserves. 2.Sweep Account -This has led to lower checking account balances and less required reserves. In a sweep account, there is usually a money market fund and a checking account combined. At the end of each business day, balances over a certain amount in the checking are transferred, or swept into the money market account. This is what has led to less required reserves on hand.

Explain two reasons why the Fed does not have complete control over the level of bank deposits and loans. Explain how a change in either factor affects the deposit expansion process.

1.Banks can hold excess reserves and the public can change its currency holdings. 2.An increase in either excess reserves or currency reduces the amount by which deposits and loans are increased.

Assume a simple banking world in which no banks hold excess reserves, and the public holds no currency. If a bank sells a $100 security to the Fed, explain the accounting process for the first two steps in the deposit expansion process, assuming a 10% reserve requirement. Now, separately assume that the deposit creation process has fully run its course. How much do deposits and loans increase for the banking system when the process is completed?

Bank A changes a security for reserves, and then lends the reserves creating loans. It receives $100 in reserves from the sale of securities. Since all of these reserves will be excess reserves, the bank will loan out all of the $100. This $100 will then be deposited into Bank B. This bank now has a change of reserves of $100, of which $90 is excess reserves. Bank B will loan out this 90$, 81 of which is excess reserves. Bank C will loan out this 81$ and the process will continue until there are no more excess reserves in the banking system. For the banking system,both loans and deposits increase by 1,000.

Explain dynamic and defensive open market operations. What is the purpose of each type? Describe two situations when defensive open market operations are used. How are defensive open market operations typically conducted?

Dynamic OMO's are used to change the monetary base and money supply permanently. Defensive are used to offset temporary changes, such as floats, shifts of treasury balances in or out the fed, and changes in currency. Defensive purchases are conducted by re-purchase agreements, and reverse repos or matched sale purchase transactions are used to conduct defensive open market sales.

Make the case For and Against an independent federal reserve

For: Having an independent federal reserve can shield the economy from a political business cycle, also having control of the money supply can be helpful when you have inexperienced politicians Against: It isn't democratic to have the money supply controlled by a small number of people who may or may not be accountable. If the fed is independent it may pursue its own interest over the publics

What factors determine a bank's holdings of excess reserves? How does a change in each factor affect excess reserves, the money multiplier, and the money supply?

Increase in market interest rates reduces excess reserves because banks profit from increased lending. If there is an increase in expected deposit, this outflow increases excess reserves. Increasing the interest rate reduces excess reserves, and increases the multiplier and the money supply. An increase in expected outflows increases excess reserves, reducing the multiplier and money supply.

Explain the Fed's three tools of monetary policy and how each is used to change the money supply. Does each tool affect the monetary base or the money multiplier?

The 3 tools are open market operations, the purchase and sale of govt. securities, discount policy, controlling the price and quantity of discount loans to banks, and reserve requirements, setting the percentage of deposits that banks must hold in reserve.Open Market Operations and the discount rate affect the monetary base, and reserve requirements affect the money multiplier.

Where does the power lie within the Federal Open Market Committee?

The 7 members of the board of governors, the president of the NY Fed, and 4 of the other 11 regional bank presidents are voting members on a rotating basis. The chairman of the board of governors has this power.

Who are the voting members of the Federal Open Market Committee and why is this committee important?

The Federal Open Market Committee determines the policy of the US through its decisions about market operations. It determines the discount rate and reserve requirements.

Goal independence

The ability of a central bank to set its goals

Instrument independence

The ability of the central bank to set its instruments

Explain the Taylor rule, including the formula for setting the federal funds rate target, and the components of the formula. If the Fed were to use this rule, how many goals would it use to set monetary policy?

The formula for setting the federal funds rate target is (Output Gap) + ½(inflation gap) or Federal Funds Rate Target = Equilibrium Federal Funds Rate + inflation rate + ½ The Taylor rule sets the federal funds rate recognizing the goals of low inflation and full employment, or equilibrium long-run economic growth.

Explain why the simple deposit multiplier overstates the true deposit multiplier.

The simple model doesn't factor in the role that banks and their customers play in the creation process. The banks customer can decide to hold currency and the bank can decide to hold excess reserves. Both of these will restrict the banking system's ability to create deposits. Thus, the true multiplier is less than the prediction of the simple deposit multiplier.

Central bank independence is important because:

There's some evidence that independent central banks pursue lower rates of inflation without harming overall economic performance

Explain and demonstrate graphically how targeting the federal funds rate can result in fluctuations in nonborrowed reserves.

With a federal funds rate target, fluctuations in demand for reserves require similar changes in non-borrowed reserves to keep the federal funds rate constant.

If a bank has excess reserves of $4,000 and demand deposit liabilities of $100,000, and if the reserve requirement is 10 percent, then the bank has actual reserves of a. $14,000. b. $19,000. c. $24,000. d. $29,000.

a. $14,000.

The Fed's support of the Depository Institutions Deregulation and Monetary Control Act of 1980 stemmed in part from its a. concern over declining Fed membership. b. belief that all banking regulations should be eliminated. c. belief that interest rate ceilings were too high. d. belief that depositors had to become more knowledgeable of banking operations.

a. concern over declining Fed membership.

In the market for reserves, a decline in the reserve requirement _______the demand of reserves, ______ the federal funds rate, everything else held constant. a. decreases; lowering b. increases; lowering c. increases; raising d. decreases; raising

a. decreases; lowering

Open market operations intended to offset movements in noncontrollable factors (such as float) that affect reserves and the monetary base are called a. defensive open market operations. b. dynamic open market operations. c. offensive open market operations. d. reactionary open market operations

a. defensive open market operations.

. The trend in recent years is that more and more governments a. have been granting greater independence to their central banks. b. have been reducing the independence of their central banks to make them more accountable for poor economic performance. c. have mandated that their central banks focus on controlling inflation. d. have required their central banks to cooperate more with their Ministers of Finance.

a. have been granting greater independence to their central banks.

Assuming initially that r = 15%, c = 40%, and e = 5%, a decrease in e to 0% causes the M1 money multiplier to____ , everything else held constant. a. increase from 2.33 to 2.55 b. decrease from 2.55 to 2.33 c. increase from 1.67 to 1.82 d. decrease from 1.82 to 1.67

a. increase from 2.33 to 2.55

When a bank sells a government bond to the Federal Reserve, reserves in the banking system ______ and the monetary base _____ everything held constant a. increase; increases b. increase; decreases c. decrease; increases d. decrease; decreases

a. increase; increases

Everything else held constant, in the market for reserves, when the federal funds rate is 5%, lowering the discount rate from 5% to 4% a. lowers the federal funds rate. b. raises the federal funds rate. c. has no effect on the federal funds rate. d. has an indeterminate effect on the federal funds rate.

a. lowers the federal funds rate.

The formula for the M1 money multiplier is a. m = (1 + c)/(r + e + c). b. M = 1/(r + e + c). c. M = (1 + c)/(r + e + c). d. m = [1/(r + e + c)] × MB.

a. m = (1 + c)/(r + e + c).

The primary goal of the European Central Bank is a. price stability. b. exchange rate stability. c. interest rate stability. d. high employment.

a. price stability.

Reserves are equal to the sum of a. required reserves and excess reserves. b. required reserves and vault cash reserves. c. excess reserves and vault cash reserves. d. vault cash reserves and total reserves.

a. required reserves and excess reserves.

The public's fear of centralized power and distrust of moneyed interests led to the demise of the first two experiments in central banking: a. the First Bank of the United States and the Second Bank of the United States. b. the First Bank of the United States and the Central Bank of the United States. c. the First Central Bank of the United States and the Second Central Bank of the United States. d. the First Bank of North America and the Second Bank of North America

a. the First Bank of the United States and the Second Bank of the United States.

The First Bank of the US: a. was disbanded in 1811 when it's charter wasn't renewed b. had its charter renewal vetoed in 1832 c. was fundamental in helping the Federal Government finance the War of 1812 d. none of the above

a. was disbanded in 1811 when it's charter wasn't renewed

In the simple deposit expansion model, if the Fed purchases $100 worth of bonds from a bank that previously had no excess reserves, the bank can now increase its loans by a. $10. b. $100. c. $100 times the reciprocal of the required reserve ratio. d. $100 times the required reserve ratio.

b. $100.

If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the money supply is a. $8000. b. $1200. c. $1200.8. d. $8400.

b. $1200.

The interest rate for primary credit is set ______ basis points ______ the federal funds rate a. 50; below b. 100; above c. 100; below d. 50; above

b. 100; above

The formula linking the money supply to the monetary base is a. M = m/MB. b. M = m × MB. c. m = M × MB. d. MB = M × m. e. M = m + MB.

b. M = m × MB.

High-powered money minus reserves equals a. reserves. b. currency in circulation. c. the monetary base. d. the nonborrowed base.

b. currency in circulation.

The political business cycle refers to the phenomenon that just before elections, politicians enact ________ policies. After the elections, the bad effects of these policies (for example,_______) have to be counteracted with_________ policies. a. expansionary; higher unemployment; contractionary b. expansionary; a higher inflation rate; contractionary c. contractionary; higher unemployment; expansionary d. contractionary; a higher inflation rate; expansionary

b. expansionary; a higher inflation rate; contractionary

The ability of a central bank to set monetary policy goals is a. political independence. b. goal independence. c. policy independence. d. instrument independence

b. goal independence.

Everything else held constant, a decrease in the currency ratio causes the M1 money multiplier to _____and the money supply to ____. a. decrease; increase b. increase; increase c. decrease; decrease d. increase; decrease

b. increase; increase

The Federal Reserve will engage in a repurchase agreement when it wants to _______ reserves _______ in the banking system. a. increase; permanently b. increase; temporarily c. decrease; temporarily d. decrease; permanently

b. increase; temporarily

The amount of borrowed reserves is _____related to the discount rate, and is____related to the market interest rate. a. negatively; negatively b. negatively; positively c. positively; negatively d. positively; positively

b. negatively; positively

Either a dual or hierarchical mandate is acceptable as long as _____ is the primary goal in the _______ a. price stability; short run b. price stability; long run c. reducing business-cycle fluctuations; short run d. reducing business-cycle fluctuations; long run

b. price stability; long run

Suppose, at a given federal funds rate, there is an excess demand for reserves in the federal funds market. If the Fed wants the federal funds rate to stay at that level, then it should undertake an open market ____of bonds, everything else held constant. If the Fed does nothing, however, the federal funds rate will ________. a. sale; increase b. purchase; increase c. sale; decrease d. purchase; decrease

b. purchase; increase

Unemployment resulting from a mismatch of workers' skills and job requirements is called a. frictional unemployment. b. structural unemployment. c. seasonal unemployment. d. cyclical unemployment.

b. structural unemployment.

Prior to 1980, member banks left the Federal Reserve System due to a. the high cost of discount loans. b. the high cost of required reserves. c. a desire to avoid interest rate regulations. d. a desire to avoid credit controls.

b. the high cost of required reserves.

If a bank has excess reserves of $10,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has actual reserves of a. $16,000. b. $20,000. c. $26,000. d. $36,000.

c. $26,000.

The central bank, which is generally regarded as the most independent in the world because its charter cannot be changed by legislation, is the a. Bank of England. b. Bank of Canada. c. European Central Bank. d. Bank of Japan.

c. European Central Bank.

Which set of goals can, at times, conflict in the short run? a. High employment and economic growth. b. Interest rate stability and financial market stability c. High employment and price level stability. d. Exchange rate stability and financial market stability.

c. High employment and price level stability.

Everything else held constant, an increase in the currency-checkable deposit ratio will mean a. an increase in currency in circulation and an increase in the money supply. b. an increase in money supply but no change in reserves. c. a decrease in the money supply. d. an increase in currency in circulation but no change in the money supply.

c. a decrease in the money supply.

The interest rate the Fed charges banks borrowing from the Fed is the a. federal funds rate. b. Treasury bill rate. c. discount rate. d. prime rate

c. discount rate.

The Federal Reserve ______ pay interest on reservesheld on deposit. The European System of Central Banks ______ pay interest on reserves held on deposit. a. does; does b. does; does not c. does not; does d. does not; does not

c. does not; does

Suppose on any given day the prevailing equilibrium federal funds rate is below the Federal Reserve's federal funds target rate. If the Federal Reserve wishes for the federal funds rate to be at their target level, then the appropriate action for the Federal Reserve to take is a _____open market_____ , everything else held constant. a. defensive; sale b. defensive; purchase c. dynamic; sale d. dynamic; purchase

c. dynamic; sale

The Federal Open Market Committee usually meets __ times a year a. four b. six c. eight d. twelve

c. eight

In the market for reserves, an increase in the reserve requirement _______ the demand for reserves, ________ the federal funds rate, everything else held constant a. decreases; lowering b. increases; lowering c. increases; raising d. decreases; raising

c. increases; raising

The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximize a. the public's welfare. b. profits. c. its own welfare. d. conflict with the executive and legislative branches of government

c. its own welfare.

Open market purchases raise the ______ thereby raising the ________ a. money multiplier; money supply b. money multiplier; monetary base c. monetary base; money supply d. monetary base; money multiplier

c. monetary base; money supply

The variable that reflects the effect on the money supply of changes in factors other than the monetary base is the a. currency-checkable deposits ratio. b. required reserve ratio. c. money multiplier. d. nonborrowed base.

c. money multiplier.

The goal for high employment should seek a level of unemployment at which the demand for labor equals the supply of labor. Economists call this level of unemployment the a. frictional level of unemployment. b. structural level of unemployment. c. natural rate level of unemployment. d. Keynesian rate level of unemployment.

c. natural rate level of unemployment.

Suppose that from a new checkable deposit, First National Bank holds two million dollarsin vault cash, one million dollars in required reserves, and faces a required reserve ratio of ten percent. Given this information, we can say First National Bank has _____million dollars in excess reserves. a. one b. two c. nine d. ten

c. nine

The most common type of discount lending that the Fed extends to banks is called a. seasonal credit. b. secondary credit. c. primary credit. d. installment credit.

c. primary credit.

In the simple deposit expansion model, an expansion in checkable deposits of $1,000 when the required reserve ratio is equal to 20 percent implies that the Fed a. sold $200 in government bonds. b. sold $500 in government bonds. c. purchased $200 in government bonds. d. purchased $500 in government bonds.

c. purchased $200 in government bonds.

A ____ in market interest rates relative to the discount rate will cause discount borrowing to ____. a. fall; increase b. rise; decrease c. rise; increase d. fall; remain unchanged

c. rise; increase

The Federal Open Market Committee consists of the a. five senior members of the seven-member Board of Governors. b. seven members of the Board of Governors and seven presidents of the regional Fed banks. c. seven members of the Board of Governors and five presidents of the regional Fed banks. d. twelve regional Fed bank presidents and the chairman of the Board of Governors.

c. seven members of the Board of Governors and five presidents of the regional Fed banks.

The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom is a. monetary targeting. b. inflation targeting. c. targeting with an implicit nominal anchor. d. interest-rate targeting.

c. targeting with an implicit nominal anchor.

If a bank has excess reserves of $20,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has total reserves of a. $16,000. b. $20,000. c. $26,000. d. $36,000.

d. $36,000.

A bank has excess reserves of $4,000 and demand deposit liabilities of $100,000 when the required reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves will be a. -$5,000. b. -$1,000. c. $1,000. d. $5,000.

d. $5,000.

If the required reserve ratio is 10 percent, the simple deposit multiplier is a. 5.0. b. 2.5. c. 100.0. d. 10.0

d. 10.0

The financial panic of 1907 resulted in such widespread bank failures and substantial losses to depositors that the American public finally became convinced that a. the First Bank of the United States had failed to serve as a lender of last resort. b. the Second Bank of the United States had failed to serve as a lender of last resort. c. the Federal Reserve System had failed to serve as a lender of last resort. d. a central bank was needed to prevent future panics

d. a central bank was needed to prevent future panics

Banks subject to reserve requirements set by the Federal Reserve System include a. only nationally chartered banks. b. only banks with assets less than $100 million. c. only banks with assets less than $500 million. d. all banks whether or not they are members of the Federal Reserve System.

d. all banks whether or not they are members of the Federal Reserve System.

Since 1980, ______ are subject to reserve requirements a. only commercial banks b. only the member institutions of the Federal Reserve c. only nationally chartered depository institutions d. all depository institutions

d. all depository institutions

Decisions by depositors to increase their holdings of _____ , or of banks to hold_____ will result in a smaller expansion of deposits than the simple model predicts. a. deposits; required reserves b. deposits; excess reserves c. currency; required reserves d. currency; excess reserves

d. currency; excess reserves

Supply-side economic policies seek to a. raise interest rates through contractionary monetary policy. b. increase federal government expenditures. c. increase consumption expenditures by increasing taxes. d. increase saving and investment using tax incentives.

d. increase saving and investment using tax incentives.

The guiding principle for the conduct of monetary policy that held that as long as loans were being made for "productive" purposes, then providing reserves to the banking system to make these loans would not be inflationary became known as the a. free reserves doctrine. b. Benjamin Strong doctrine. c. efficient liquidity doctrine. d. real bills doctrine.

d. real bills doctrine.

The monetary policy strategy that suffers a lack of transparency is a. exchange-rate targeting. b. monetary targeting. c. inflation targeting. d. the implicit nominal anchor.

d. the implicit nominal anchor.

The Fed is politically independent due to its:

earnings and the conditions of appointment of the Board of Governors and its chairman

2 concepts of central bank independence

instrument independence and goal independence