ECON 355 Exam 4

Why is high employment a worthy goal? What does it mean, and how does it relate to potential output?

1) the alternative situation of high unemployment causes much human misery 2) it reduces idle workers and idle resources. It means the natural rate of unemployment, where supply of labor equals demand of labor. Potential output is the amount produced when operating at the natural rate of unemployment.

What elements are involved with the monetary policy strategy of inflation targeting?

1. Public accouchement of medium-term numerical targets for inflation 2. an institutional commitment to price stability as the primary, long-run goal of monetary policy and a commitment to achieve the inflation goal 3. an information-inclusive approach in which man variables are used in making decisions about monetary policy 4. increased transparency of monetary policy strategy through communication with the public and the markets about the plans and objectives of monetary policy makers 5. increased accountability of the central bank for attaining its inflation objectives

What four elements did the Fed add to the Truth in Lending Act in July 2008?

A bank on lenders making loans without regard to borrowers' ability to repay the loan from income and assets other than the home's value, a ban on no-doc loans, a ban on prepayment penalties if the interest payment can change in the first 4 years of the loan, and a requirement that lenders establish an escrow account for property taxes and homeowner's insurance to be paid into on a monthly basis.

If we want less risky commercial banking, what is a better way to get it?

A better way to get it is to increase capital requirements

What have economists described as the two primary channels through which the financial crisis depressed economic activity? Explain how these work.

A buildup in household debt in early 2000's that dampened household spending as house prices fell; also, there were fragilities in the financial system that resulted in a panic and credit crunch

How can a central bank act as a Pied Piper of credit? How might this led to a credit crunch?

A central bank's own exemption from adverse clearings allows it to lead them all, "Pied Piper fashion" in a general overexpansion by adding to the aggregate, effective supply of commercial bank's reserves. As the central bank expands, the reserve-supply schedule shifts to the right and the equilibrium volume of aggregate spending increases. If aggregate supply schedules are assumed, prices will be bid up, triggering an external drain of specie from the central bank-- this puts the central bank in danger of imminent default and it tries to save itself by aggressively contracting credit. This contraction reduces commercial bank's reserves, forcing them to contract as well, triggering a credit crunch.

What is a dual mandate? What is the mandate of the Federal Reserve?

A dual mandate is a desire to achieve two goals at once: the fed's is price stability and maximum employment

What is the Taylor Rule? What does it indicate about monetary policy in the early 2000s?

A formula that provides a standard method of estimating what federal funds rate would be, depending on current inflation and real income, keeping inflation rate to a chosen target rate. IT indicated that in early 2001-2006, the Fed pushed actual fed funds rate below estimated rate that would have been consistent with targeting a 2% inflation rate.

What is regulatory arbitrage, and to what did risk-based capital ratios (the Basel Accords) lead?

A practice in which banks keep on their books assets that have the same risk-based capital requirement but are relatively risky, such as a loan to a company with a very low credit rating, while taking off their books low-risk assets, such as a loan to a company with a very high credit rating; This led to increased risk taking, opposite of its original intent.

What does it mean for the regional Federal Reserve banks to be "quasi-private"? What do the Fed member banks in each region receive for their membership?

A quasi-public institution is one that is part private and part government; member banks purchase stock in their district Fed Reserve bank and receive dividends that are limited by law to 6% annually

What elements of regulation and supervision can be used to prevent excessive risk taking that can trigger a credit boom? Do you think these elements have been effective at minimizing risk?

Adequate disclosure and capital requirements, prompt corrective action, close monitoring of financial institutions' risk management procedures, and close supervision to enforce compliance with regulations. I think they have been generally more successful than dealing without them, but they clearly haven't stopped all the risk bubbles from bursting.

What are ARMs? How might they have played a role in the housing crisis?

Adjustable rate mortgages; many new mortgage-borrowers pursued an ARM, thinking that the Fed would keep long-term interest rates low indefinitely—as rates rose, monthly payments also rose and people became unable to pay their loans

Throughout the world, is deposit insurance a good thing?

Adoption of deposit insurance may be the wrong solution for promoting stability and efficiency of banking systems in emerging market countries, but it is more effective in developed economies.

Who regulated national banks after the Civil War? What was one crucial requirement?

After the Civil War, the federal government regulated national banks. One requirement was that national banks accept each other's currency at par, which helped reduce costs of valuing other bank's currency as well as prevented the discounting of notes from banks that were over-issuing and reducing the value of their notes.

How does agency theory provide a basis for the definition of a financial crisis?

Agency theory is the analysis of how asymmetric info problems can generate adverse selection and moral hazard problems-- The asymmetric information problems act as a barrier to financial markets channeling funds efficiently from savers to households and firms with productive investment opportunities and are often described as financial frictions

In what ways is the Board of Governors actively involved in monetary policy decisions?

All 7 governors are members of FOMC and vote on conduct of open market operations, it sets reserve requirements and approves or disapproves the discount rate established by the Fed Reserve banks, and the chair of the Board advises the president of the US on economic policy, testifies in Congress, and speaks for Fed Reserve to media

What, according to Wallach, are potent tools for keeping banks safe and dismantling those determined to be unsafe?

Along with the Volcker Rule, Dodd-Frank also creates a Financial Stability Oversight Council with significant discretionary powers to wield an Orderly Liquidation Authority; it addresses capital requirements; and it creates an Office of Financial Research charged with independently monitoring systemic stability-- these are all potent tools

What, according to Beddoes, are the imminent risks associated with the savings glut?

America's role as the global consumer of last resort will become unsustainable before the rest of the world works off its savings surplus—this could be triggered by gas prices as well a house-price bust

How did housing trends in the early 2000s affect Americans' savings and borrowing?

Americans are saving less and borrowing more.

How do open market operations affect the fed funds rate and the quantity of reserves?

An open market purchase causes the federal funds rate to fall whereas an open market sale causes the federal rate to rise; an open market sale decreases the quantity of nonborrowed reserves supplied and an open market purchase increases quantity. The interest rate paid on reserves sets a floor for the federal funds rate

When are bank examinations conducted? What happens if a bank's assets are too risky or its capital is too low?

Bank examinations are conducted by bank examiners at unannounced times in order to prevent anything from being "swept under the rug"; If a bank is holding securities/loans that are too risky, the bank examiner can force the bank to get rid of them. If the examiner feels that it does not have sufficient capital, the bank can be declared as a "problem bank" and will be subject to more frequent examinations.

Who, according to Rajan, share the blame for the crisis? Does he blame specific politicians or political parties?

Bankers, regulators, governments, households, and economists are to blame; he blames specific politicians, but is bipartisan.

How did government program create moral hazard? How do Krugman and Wells think this affected the subprime crisis?

Banks were forced to lend to low-income borrowers regardless of risk, but they didn't worry much about risk because they believed the government would back them up; they think that Fannie Mae and Freddie Mac did not single-handedly cause the subprime crisis

What is the Volcker rule?

Banks would be limited in the extent of their proprietary trading (trading with their own money) and would be allowed to only own a small percentage of hedge and private equity funds.

What is bear raiding? (This description is short. You may want to google for more detail.)

Bear raiding is when a large player forces share prices lower by placing large sell orders. The price plunges as stops are hit, adding to the selling; it is the illegal practice of ganging up to push a stock's price lower through concerted short selling and spreading adverse rumors about the targeted company

Should central banks respond to asset-price bubbles? What is the "lean versus clean" debate?

Because asset prices affect business and household spending and hence economic activity, monetary policy certainly needs to respond to asset prices in order to stabilize the economy. 'Lean v. Clean" refers to whether policy should try to slow bubbles before they burst, or solely focus on cleaning them up after they occur.

How might growing imbalances weaken America's economy? How does the global saving glut keep capital cheap?

Because the extra foreign debt the country has taken on as well as the domestic toll of being the world's consumer of last resort—America is saving too little and not investing enough

Does skepticism about QE mean the Fed's nonconventional monetary policy was ineffective?

Ben Bernanke argued that the answer is no because the Fed's policies were directed not at expanding the Fed's balance sheet but rather at credit easing. Thus, the Fed's policies should not be characterized as quantitative easing.

What evidence does the NBER news letter provide for Sumner's hypothesis?

Borrowers who did not start out with high LTV's still lost their homes to foreclosure; The economic cycle was more important than initial buyer, housing, and mortgage conditions in explaining the foreclosure crisis.

What three approaches are actively being debated to end the too-big-to-fail problem?

Break up Large, systematically important financial systems (make sure that no financial institutions are so large that they can bring down the financial system); Higher capital requirements (impose higher capital requirements to allow the large institutions to have a larger buffer to withstand losses as well as reducing moral hazard and giving them less incentive to take risk; Leave it to Dodd-Frank (let Dodd-Frank eliminate problem, since it makes it harder for Fed Reserve to bail out financial institutions, it increases regulations for SIFIs, and through the application of the Volcker rule.

How is economic growth related to employment? Is high growth a good goal for central banks?

Businesses are more likely to invest in capital equipment and increase productivity and economic growth when unemployment is low. Central banks should be more focused on inflation and interest rates than high employment, but one of the fed's three goals is low and stable unemployment.

How much did stock prices, commercial lending, and investment spending fall from 1929 to 1933?

By mid 1932, stocks had declined to 10% of their value at the 1929 peak. From 1929 to 1933, the amount of outstanding commercial loans fell by half and investment spending collapsed, declining by 90% from its 1929 level.

How did the money supplies of the US and Canada behave from 1800 to 1900? What do their patterns suggest about the more-regulated versus less-regulated banking systems?

Canadian bank notes fluctuated, but have an overall upward trend, while the US has a more stable pattern, but is relatively decreasing over the years. The patterns suggest that less regulation was better.

What are Bagehot's three rules for last-resort lending? Did the Fed follow these rules during the financial crisis? What is the evidence for each?

Central banks should lend on familiar collateral, they should lend freely, but at a penalty, and they should announce their intent to follow these policies beforehand

What functions do the 12 Federal Reserve banks perform?

Clear checks and hold reserve deposits of banks, issue new currency and withdraw damaged currency, evaluate proposed mergers and applications for banks to expand their activities, collect data on local business conditions, use staffs of professional economists to research topics related to conduct of monetary policy

Who was highly congenial to Glass's ideas? Who were vocal and active supporters?

Dedicated securities firms were highly congenial to Glass's ideas-- they would benefit greatly from having a large part of their competition banned; dedicated investment banks remained the most vocal and active supporters of maintaining a "wall of separation"

In what ways are the twelve Federal Reserve banks involved in monetary policy?

Directors "establish" discount rate, they decide which banks can obtain discount loans from Fed Reserve bank, their directors select one commercial banker from each bank's district to serve on the Federal Advisory Council, Five of the 12 bank presidents each have a vote on the FOMC

How does Rajan respond to Krugman's argument that Europe too had housing bubbles?

ECB had low interest rates too, so low interest rates weren't the sole reason; more specified in certain European countries, where it was evenly widespread throughout US.

How are the governors of the Federal Reserve System selected? How long do they serve and why? What about the chair of the Board of Governors?

Each governor is appointed by the president of the US and confirmed by Senate; they serve for a nonrenewable 14-year term plus part of another term; the chair serves renewable 4 year terms and the old chair is expected to resign upon election of a new one.

What did early studies of RBC regulation find? What about more recent studies?

Early studies favored the RBC ratios, while more recent studies find that complex RBC regulations are not effective predictors of risk.

How can a credit boom spill over into an asset-price bubble? Why are credit-driven bubbles particularly dangerous? What about bubbles from excessive optimism?

Easier credit can be used to purchase particular assets and thereby raise their prices. This is especially dangerous because the rise in asset values encourages further lending for these assets which increases demand and prices for the assets even more. The burble that busts causes the feedback loop to collapse.

What does empirical research find about the relationship between central bank independence and macroeconomic performance?

Empirical evidence supports that countries with independent central banks have better inflation performance and macroeconomic performance

How are banks in free banking systems analogized to prisoners in a chain gang?

Escape is impossible for any single prisoner acting alone and especially for the group as a whole because of the difficulty its members will encounter in trying to coordinate their steps-- the greater the size of the gang, the more difficult escape becomes.

In the structure of the Fed, what three groups of entities are in charge of monetary and regulatory policy? How many members in each group?

Federal Reserve banks (9 directors in each), Board of Governors (7 members), and FOMC ( 7 members of board of governors + presidents of FRB of NY +4 other FRBs)

Why is it difficult to get regulators and supervisors to do their jobs properly?

First, financial institutions, in search for profits, have strong incentives to avoid existing regulations by loophole mining. Thus, regulation applies to a moving target--regulators are continually playing cat-and-mouse with financial institutions (they think up clever ways to avoid regulations, which then lead regulators to modify their regulation activities).

How might altering the composition of the Fed's balance stimulate the economy?

First, the Fed can provide liquidity to a frozen segment and help stimulate it as well as the economy. Secondly, when the Fed purchases securities, it increases the demand for those securities and it can lower the interest rates on those securities relative to other securities.

Why might conventional monetary policy tools not be effective in a full-scale financial crisis?

First, the financial system seizes up to such an extent that it becomes unable to allocate capital to productive uses and investment spending and the economy collapses. Second, the negative shock to the economy can lead to the zero-lower-bound problem, in which the central bank is unable to lower the policy interest rate further because it has hit a floor of zero.

What two challenges does financial consolidation pose because of the government safety net?

First, the increased size of financial institutions resulting from financial consolidation increases the too-big-to-fail problem because there are now more large institutions whose failure would expose the financial system to systemic risk; Second, financial consolidation of banks with other financial services firms means that the government safety net may be extended to new activities, such as securities underwriting, insurance, or real estate activities-- something which occurred during the global financial crisis.

What would have to be proved for Stewart to be charged with insider trading? For what was Stewart ultimately sentenced? What about the charges for insider trading and fraud?

For Stewart to be charged with insider trading, it would have to be proved that she acted upon nonpublic information; Stewart was sentenced to 5 months of prison time for obstruction of justice and conspiracy after the insider trading charges were dropped and securities fraud charges dismissed

What are the implications of the principle of adverse clearings?

For an increase in the velocity of money, the result will be an excess demand for reserve, causing banks to reduce their lending and reduce liabilities; a decrease in velocity of money will have the opposite effect; it also has implications for the preservation of international monetary equilibrium.

What happens if the privilege of note issue is granted to a single bank? What will less-privileged ("commercial") banks tend to do in this case?

For domestic exchanges, paper notes will be preferred to coins due to convenience. Banks that are denied the right to issue their own currency will stock and reissue notes from the privileged bank. Less-privileged banks will tend to send their specie to the privileged (central) bank, which will consequently become the sole custodian of the nation's specie reserves.

What is the "global savings glut"? How did Bernanke think it affected the US economy?

Foreign countries were heavily investing their money into the US, driving down long-term interest rates; the impact of the savings glut was mainly on housing- low mortgage rates caused more people to buy houses, artificially driving up the prices of housing to ridiculous prices.

How does information efficiency benefit the average investor?

Getting information to the market as quickly as possible helps to alleviate asymmetry and allow that information to reach a maximum of participants as quickly as possible.

Why does the Fed chair have so much power? How does the chair exercise power?

He/she is the spokesperson for the Fed and negotiates with Congress and the president of US; he/she also exercises control by setting agenda of Board and FOMC meetings; the chair also influences the board through force of stature and personality; in addition, the chair exercises power by supervising the Board's staff of professional economists and advisers

How were GDP growth and employment from the end of 2008 to the summer of 2009? How did they change after June 2009?

Growth was dramatically lower and unemployment was growing very quickly; it stabilized after the summer

What does Rajan argue regarding the political push to expand housing credit? What does Krugman dispute (and not dispute)?

He argues that politicians pushed agencies like Freddie mac and Fannie Mae too hard on public to offset rising income gap; Krugman doesn't dispute the incentives of the politicians nor documentation of government mandates, but he does dispute whether government policy contributed to the housing bubble and whether Fannie and Freddie were responsible.

Who, according to Roth, is harmed by insider trading?

He believes that there is no victim, since the mere act of one side profiting does not have a direct impact on the counterparty

What does Levine mean that Sarao was trading E-mini S&P 500 futures but was looking for "a more convenient way to not trade them"? What was the idea?

He emailed his future commission merchant (broker) for help automating the process-- he wanted a "cancel if close" function; the idea is that he would put in a big order to sell a whole bunch of futures at a price a few ticks higher than the best offer-- he wouldn't sell any futures, since he wasn't offering the best price. But he had to keep constantly updating his orders to keep them a few ticks higher than the best offer, to make sure that he didn't accidentally sell any futures as the market moved.

What did FDIC Chairman Isaac think of Glass-Steagall? What did the Gramm-Leach-Bliley Act (GLB) do when it finally came along?

He thinks that Glass-Steagall threatens the long-term health and survival of banks as the fulcrum of our regulatory system; when GLB finally came along, it equalized competition that regulators had been incrementally allowing, rather than revolutionizing the regulatory system.

How many E-mini futures contracts did Sarao trade during the crash, and what was his profit?

He traded 62,077 E-mini S&P contracts with a notional value of $3.5 billion -- and made approximately $879,018 in net profits that day.

How was Sarao's trading an example of "classic spoofing"?

He'd place a lot of big orders to sell, everyone else would say see all the big sell orders and would eventually sell, the market would go down, he'd buy, he'd turn off his algorithm, everyone else would recognize there are no more sell orders, causing them to buy since the market had apparently returned back to normal, the price would go back up, and Sarao would sell the futures he'd bought at a lower price a moment ago.

What did the asset price boom in the housing market mean for subprime borrowers and the demand for houses?

High housing prices meant that subprime borrowers could refinance their houses with even larger loans when their homes appreciated in value. With this increased price, subprime borrowers were also unlikely to default because they could always sell off their house to pay the loan. This generated a big demand for houses and fueled the growth in popularity of subprime mortgages.

In what ways did rising home prices and profitable mortgage origination lead to falling underwriting standards for subprime mortgages (LTV, piggyback, etc.)?

High risk borrowers were able to obtain mortgages and the amount of mortgage relative to the value of the house (LTV) rose. Borrowers were often able to get piggyback, second, and third mortgages on top of their original 80% loan-to-value mortgage, so that they had to put almost no money down.

How, according to Rajan, have Krugman's views on Fannie Mae and Freddie Mac changed over time?

His explanations have morphed as his errors have been pointed out—First he argued that Fannie and Freddie could not participate in sub-prime financing; then, he argued that their share of financing was failing in the years mortgage loan quality deteriorated the most; Now, he claims that if they indeed did it, it was because of the profit motive and not to fulfill a social objective.

Does Blinder think the Fed's monetary policy deserves blame for the crisis?

IT kept money and credit too loose for too long, but the economy still needed help recovering from previous recession.

Why would "big guys would actually make less money if you got rid of insider trading"?

If insider trading were legal, you would have more participants seeking out that information, so not only would it get to market faster, it will lessen the reward and profits of those trading on it

How can uncertainty lead to asset fire sales and bank panics?

In a panic, depositors withdraw their deposits to the point that banks fail. This uncertainty can also result in fire sales, where banks sell off assets quickly to raise necessary funds to prevent insolvency.

How are regulators studying regulations to modify compensation in the financial services industry to reduce risk taking?

In the Fed Reserve, they are in the process of implementing "clawbacks" that will encourage employees to reduce the riskiness of their acts so that they are more likely to receive their bonuses in the future.

What would have happened to GDP in the absence of the financial panic?

In the absence of the panic, the declines in employment, consumption, and output in the early stages of the Great Recession would have been significantly less severe

What is one of the most straightforward ways to get a safer, less-leveraged banking system? How has leverage been affected by prudential standards under Dodd-Frank?

Increasing capital requirements is one of the most straightforward ways to get a safer, less-leveraged banking system; As a result of Dodd-Frank requiring adoption of prudential standards, including capital requirements, overall leverage is down.

What is the problem of delayed signaling?

Inflation outcomes are revealed only after a substantial lag, thus, an inflation target is unable to send immediate signals to both the public and markets about the stance of monetary policy

How can the president influence the Federal Reserve? How is this power limited? Do you think these limits are likely to work in practice?

Influencing Congress and legislation, electing new board governor and electing new chairs; However, this is limited in that the term of the chair is not necessarily concurrent with that of the president, meaning the president might have to deal with a chair from a previous administration; I do not think these limits work, since a president can appoint a new chair member and the current one will have to resign by force.

When does insider trading become illegal? With what was Martha Stewart charged?

Insider trading becomes illegal when a person bases their trade of securities of a public company on information that the public does not know; Acting upon an insider stock tip is exactly what Martha Stewart was charged with

What is the most basic definition of insider trading, and what can it include?

Insider trading is the trading of a public company's stock or other securities by individuals with access to nonpublic, or insider, information about the company; This can include the perfectly legal buying and selling of stock by a company's corporate insiders. But it can also include illegal actions of individuals attempting to benefit from a trade based on that inside information.

What are two types of central bank independence (name and explain)?

Instrument independence, the ability of the central bank to set monetary policy instruments; goal independence, the ability of the central bank to set the goals of monetary policy

Who was hurt, and who is filing lawsuits?

It depends. If Libor was artificially high when you took out a loan, then you paid more on the loan than you should have. Conversely, if Libor was artificially low, you may have paid less than you should have; Naturally, those who figure they were ripped off are filing lawsuits.

What is the narrative of laissez-faire banking, and to what are market failures supposed to lead?

It describes a period where producers (banks) took advantage of the lack of regulations to harm their customers and cause market-wide inefficiencies. These failures led to calls for government action and defenders of government intervention claim that the regulations and new institutions solved the problems the free market created.

In what ways is the standard treatment of central banks one-sided

It has a tendency to focus on ideal rather than actual central-bank conduct. It also assumes that however much central banks might depart in practice from ideal policies, they at least succeed in limiting the amplitude of booms and busts.

What are the side effects on banks and financial institutions of the Fed's last resort lending?

It has created a moral hazard problem: Banks take on more risk, thus exposing taxpayers to greater losses; it also may encourage financial institutions to take on greater risk

How does David Hume's "price-specie-flow" mechanism work?

It helps to restore purchasing power parity by promoting monetary contraction in the country where goods are more expensive and, on the other hand, monetary expansion where goods have been less expensive.

What is a nominal anchor, and what is its role in monetary policy?

It is a nominal variable such as the inflation rate or money supply that ties down the price level to achieve price stability. A nominal anchor promotes price stability.

What, really, is a central bank?

It is fundamentally a bank that possesses a national monopoly or something approaching a national monopoly of the right to issue circulating paper currency

Why is the federal funds rate particularly important to the Fed? How is it indicative of monetary policy? Why might the book be wrong about this? (Think about the EMH: Does good news mean the stock price will rise?)

It is important in the conduct of monetary policy because it is the interest rate that the Fed tries to influence directly; thus, it is indicative of the Fed's stance on monetary policy. The book could be wrong about this, since sometimes the Fed's actions have reverse effects on interest rate and they sometimes achieve results they don't desire.

Why is monetary policy important to understand? How can it be good or bad?

It is important to understand correctly because mistakes can cause enormous problems. Not creating enough money can lead to massive deflation and a possible recession. Creating too much money can lead to serious inflation problems, resulting in damages to economy.

What are the advantages of inflation targeting?

It is readily understood by the public and highly transparent. It increases the accountability of the central bank, and has the potential to reduce the likelihood the central bank will fall into insolvency. Helps focus on what a central bank can do in the long-run, not the short run.

Why does the Fed act as a lender of last resort even though deposits are insured by the FDIC?

It is there to prevent bank failures from spinning out of control and to provide reserves to banks when no one else would, thereby preventing bank and financial panics; discounting is an effective way to provide reserves to banking system during banking crisis; If a large number of banks failed, the FDIC would not be able to cover all.

According to the utility and casino theory, what did ending Glass-Steagall do? How does this "specious syllogism" run?

It led directly to the crisis in 2008; the specious syllogism runs like this: commercial banking should be boring, commercial banking was boring under Glass-Steagall from 1933-1999, therefore we should bring back Glass-Steagall

In what unprecedented ways did the Fed intervene after the failure of Lehman Brothers?

It led to a Commercial Paper rescue program as well as a MBS purchase program, which is still in progress

How did America's role as "global consumer of last resort" affect public finances and productivity?

It left it very vulnerable—low interest rates fueled a property boom, lulling consumers into thinking that there is no need to save

Why is too much rigidity a problem for monetary policy rules? How is inflation targeting actually practiced?

It limits their ability to respond to unforeseen circumstances. It is actually practiced more like "flexible inflation targeting," requiring the central bank to use all available information to determine which policy actions are appropriate.

What does the Financial Stability Oversight Council (FSOC) do? How does it regulate systemically important financial institutions (SIFIs)?

It monitors markets for asset-price bubbles and the buildup of systematic risk. In addition, it designates which financial firms are systematically important and so would receive the official designation of systematically important financial institutions (SIFIs); The Federal Reserve would regulate these firms by imposing higher capital standards and stricter liquidity requirements as well as requirements that they draw up a plan for orderly liquidation if the firm gets into financial difficulties (living will).

What is the new resolution authority allowed by the Dodd-Frank Act?

It now provides the US government with the ability to seize failing banks that are "systematic"- firms who pose a risk to the overall financial system because their failure would cause widespread damage; it also gives regulators the right to levy fees on financial institutions with more than $50 billion in assets to recoup any losses

What is deleveraging? What effect does it have on a credit boom?

It occurs when financial institutions cut back on their lending to borrow-spenders; with less capital, banks and other financial institutions become riskier, causing lender-savers and other potential lenders to these institutions to pull out their fund-- fewer funds means fewer loans, resulting in a credit freeze; the credit boom turns into a credit crash.

How did regulations affect the adjustment of currency in response to changes in demand? How were Canadian banks unlike their US counterparts, and what was the result?

It prevented the stock of currency from adjusting along with seasonal increases in demand. Canadian banks, unlike US, were free to issue notes on the same general assets that supported their deposit liabilities. They were capable of accommodating both secular and seasonal changes in the demand for currency.

How can a government safety net (the FDIC) short-circuit runs on banks and bank panics?

It provides protection for the depositor, fully covering them on their first $250k.

What is the strongest case for central bank independence? What does the research on political business cycles find?

It rests on the view that subjecting it to more political pressures would impart an inflationary bias to monetary policy; research suggests that just before an election, expansionary policies are pursued to lower unemployment and interest rates. After the election, high inflation and interest rates return, requiring contractionary policies that politicians hope the public will forget before the next election.

Why, according to Levine, is "the FBI's and CFTC's theory here is far more troubling" than alternative theories?

It suggests that existing algorithms are not just dumb enough to give spoofers some of their money, but dumb enough to give spoofers so much of their money that they destabilize the financial markets

What does the fact that low interest-rates from 2002 to 2005 were followed by excessive risk taking suggest? How do low interest rates affect risk taking by asset managers and lenders?

It suggests that overly easy monetary policy might promote financial instability. Low interest rates may increase the incentives for asset managers in financial institutions to search for higher yields and hence increase risk taking.

What does the theory of bureaucratic behavior predict suggest about the Fed? Are such predictions consistent with the Fed's actual behavior?

It suggests that the objective of a bureaucracy is to maximize its own welfare, just as a consumer's behavior is motivated by the maximization of personal welfare and a firms behavior is motivated by the maximization of profits; it is consistent with the Fed's behavior in that it will fight to preserve its autonomy as well as avoid conflict with powerful groups that could hinder its power.

How did the FOMC confuse the financial crisis as a technical issue regarding illiquidity rather than a macroeconomic issue calling for monetary easing?

It was still focused on preventing high inflation and waited too long before cutting interest rates

Why, according to Blinder, does the Fed deserve particular blame for regulatory neglect?

It was the only regulator with systematic responsibilities, it was the "primus inter pares" among financial regulators, and it had been assigned by Congress special responsibilities for both mortgages and consumer protection

What happens to a bank that expands its balance sheet (note issue) further than its rivals?

It will face a corresponding absolute and relative increase in the return flow of its notes (or checks) through the clearing system and a corresponding net loss of reserves, which will leave it with an inadequate reserve cover if it does not default outright.

What is special about the role played by the Federal Reserve Bank of New York?

Its district contains many of the largest commercial banks in the US; it's the supervisor of some of the most important financial institutions in our financial system; it is very involved in the bond and foreign exchange markets; also, it is the only Federal Reserve bank to be a member of the Bank for International Settlements; finally, the president of the bank is the only permanent voting member of the FOMC among Fed Reserve bank presidents.

Do John Taylor and Ben Bernanke think the Fed is to blame for the housing price bubble?

John Taylor argues that the Fed Reserve is to blame, while Ben Bernanke concluded that the culprits were new mortgage products that lowered mortgage payments, lax lending standards, and capital inflows from foreign countries.

What is fake news? (In trading, not politics.) What is the traditional wisdom about it?

Large or media-savvy stock market players have long attempted to spread the fake news about a company or even the entire market to make it move in their favor. The shady world of penny stock promoters is the classic example of fake news being used to manipulate stock prices. Protect yourself from fake news by always confirming the source of the news before acting upon it. Be warned though that the time drain from this can result in your missing the move.

What are some reasons central banks should try to pop asset-price bubbles?

Leaning against credit bubbles, which would involve leaning against credit-drive asset price bubbles but not irrational exuberance asset-price bubbles. When asset prices are rising at the same time that credit is booming, it is more likely that asset prices are deviating from their fundamentals. Central bank and government officials have a greater likelihood of identifying a bubble in process.

What is price stability (as a goal for central bankers), and why is it important?

Low and stable inflation. It is important because a rising price level creates uncertainty that might hamper economic growth. For example, when the overall level of price is changing, the information conveyed by the prices of goods and services is hard to interpret.

Based on previous chapters and in-class discussions, how might banks be able to alleviate asymmetric information and customer uncertainty in order to prevent runs and panics?

Make all information regarding banks available to the public-- info about the health and structure of bank that would influence investors' decisions

What, according to Krugman, should we have done to produce a faster recovery?

More fiscal policy instead of monetary policy

Is more regulation always better? Why or why not?

More regulation is not always better. Some degree of regulation can help improve financial stability, but complex and overlapping regulations can lead to banks increasing their risk-taking activities

How does discount lending affect the fed funds rate and the quantity of reserves?

Most changes in the discount rate have no effect on the federal funds rate; however, if the demand curve intersects the supply curve on its flat section, there is some discount lending and the changes in discount rate do affect the federal funds rate; quantity of reserves remains the same unless the discount lending occurs, which would then either increase or decrease.

What did most economists think about financial crises of the type experienced during the Great Depression? What did the financial crisis of 2007-2009 prove?

Most economists thought that the financial crisis of the type experienced during the Great Depression was a thing of the past for advanced countries, but the crisis from 2007-2009 proved them wrong.

Were central banks first established as stabilizing institutions? For what were they designed?

No, started as public banks and later became full-fledged banks that were established solely for the purpose of catering to their sponsoring governments' fiscal needs--by managing their deposits, administering their debt, and accommodating short-run credit needs.

Is the Fed some kind of ideal central bank that economists would draw up on a blackboard to implement? Should its performance come as a surprise?

No--the Fed was a product of political compromise. Politics produces regulations and institutions that reflect the interests of the parties involved in the process, and the Fed is no different. It should come as no surprise that the Fed has not performed well over its lifetime.

Did Stewart explicit knowledge of the FDA's decision about ImClone's drug approval? What did her broker Peter Bacanovic know?

No; Stewart had actually acted upon a tip from her Merrill Lynch broker, Peter Bacanovic, whom also worked with Waska; He knew that Waskal was attempting to unload his large stake in his company

What happened to the British bank Northern Rock?

Northern Rock, which had relied on short-term borrowings in the repo market rather than deposits for its funding, collapsed in September 2007

According to Blinder, could the Fed have stopped the leverage binge with the weapons at its disposal at the time?

Not fully and not by itself, due to the need for the SEC to deal with investment bank leverage

How is Libor calculated?

Once a day, major London banks tell Thomson Reuters the interest rate they would expect to pay on a loan from another bank. Thomson Reuters drops those rates in the highest and lowest 25% and averages the 50% in the middle.

What is a competitive or "free" banking system?

One in which numerous banks enjoy equal rights to issue their own distinct brands of circulating notes

How do the Fed's four tools of monetary policy affect the supply and demand curves for reserves?

Open market operations and discount lending affect the federal funds rate by injecting reserves into the banking system, thereby changing the supply of reserves while the reserve requirements affects the federal funds rate by changing the demand for reserves. The interest rate paid on reserves affects the federal funds rate by changing the interest paid on reserves

What is a pump and dump scam?

Pump and dump manipulators send out millions of glowingly bullish proclamations about a company to attract buyers; The "pump" occurs as the retail masses buy into the stock, resulting in the price and volume spiking higher. Once the regular investors are committed to the stock, the promoters sell their shares ("the dump"), causing the price to plunge.

Have central bankers come to use price stability as a long-run or short-run goal? To what do attempts to stabilize short-run prices lead and why?

Price stability is used in the long-run; attempts to stabilize short-run prices lead to excessive output fluctuations because of short-run inflation.

How have credit rating agencies been affected, and what may still need to be done?

Regulations to restrict conflicts of interest at credit-rating agencies and to give them greater incentives to provide reliable ratings have been strengthened in aftermath of global financial crisis; The inaccurate ratings provided by the credit-rating agencies helped promote risk taking throughout and led to investors' not having the info they needed to make informed choices about their investments--the reliance on credit ratings in the Basel 2 capital requirements may also need to be rethought, given the poor performance of credit-rating agencies in recent years.

What do regulators argue about risk-based capital (RBC) regulation? When can such regulations be problematic?

Regulators argue that the RBC ratio is more effective than the simple leverage capital ratio because it accounts for the riskiness of different bank assets. This can be problematic when regulators misjudge the risk of particular assets (Ex: MBS's)

What are required and excess reserves? What is the reserve ratio?

Required reserves are reserves that the Fed requires banks to hold; any additional reserves the banks choose to hold are called excess reserves; the reserve ratio is the fraction of deposits that banks are required to hold as reserves with the Fed.

How is adverse selection a problem with government safety nets like deposit insurance?

Risk-loving entrepreneurs might find the financial industry a very attractive one--they know they will be able to engage in highly risky activities; also, there is possibility for embezzlement due to a lack of government intervention.

What was the exact date that signaled the start of the financial crisis, and what was the event that triggered it?

September 15, 2008 when Lehman Brothers filed for bankruptcy

What other duties does the Board of Governors have that are not related to monetary policy?

Set margin requirements, sets the salary of the president and all officers of each Fed Reserve bank and reviews budget, approves bank mergers and applications for new activities and supervises the activities of foreign banks in US, and has a staff of professional economists for economic analysis.

How might inflation targeting lead to increased output fluctuations?

Sole focus on inflation may lead to monetary policy that is too tight when inflation is above the target and thus leads to larger output fluctuations.

What is at the heart of the controversy?

Some banks artificially inflated or deflated their rates, depending on what would benefit them most. Some may have deflated their rates to give the impression that they were more creditworthy than they actually were.

Why, then, didn't we get the fiscal policy we should have had? What villains does Krugman suggest?

Some key Obama figures were against giving economy the support it needed; they did not consider the severity of unemployment, and Republicans blocked attempts to rescue the economy; villains- Christina Romer and Republicans

What issues does Blinder raise regarding Too-Big-to-Fail policy?

Some observers worry that this restriction of the Fed's emergency lending authority will weaken the Fed's ability to contain future systemic crises

According to Blinder, did the Fed follow Bagehot's rules for last-resort lending? How?

Sort of; the central bank lent freely against "decent" collateral and charged a very small penalty rate

What is spoofing?

Spoofing, also known as layering, the tape is when sophisticated short-term investors place orders in the market with no intention of having them filled. Other investors see the large orders waiting to be executed, believing that a market whale is trying to buy or sell at a certain price. Therefore, the investor places their order at the same level to buy or sell.

What started in the stock market in March of 2009? How has the pact of recovery been?

Starting in March 2009, a bull market in stocks got under way and credit spreads began to fall. With the recovery in financial markets, the economy started to recover, but the pace of recovery has been slow.

What are four routes that might be taken to reform the GSEs Fannie Mae and Freddie Mac?

Take away their government sponsorship; take away their private status and make them government agencies; strengthen regulations to restrict the amount of risk they take and to impose higher capital standards; force them to shrink dramatically so they no longer expose the taxpayer to huge losses or pose a systemic risk to the financial system when they fail

What is the risk-based capital ratio, and how does it work?

The Basel Committee on Banking Supervision implemented the Basel Accord, which deals with risk-based capital requirements. The initial Basel Accord, which still applies to all but the largest banks in the US, requires that banks hold as capital at least 8% of their risk-weighted assets. Assets are allocated into four categories, each with a different weight to reflect the degree of credit risk.

How independent is the ECB relative to the Fed? What is the ECB's long-term goal?

The ECB is the most independent central bank in the world. The long term goal is price stability

What is prompt corrective action (short description)? What is group 5 and what happens to banks in this group?

The FDIC Improvement Act of 1991 adopted these action provisions that require the FDIC to intervene earlier and more vigorously when a bank gets into trouble; Banks in group 5 are critically undercapitalized and are not allowed to pay interest on their deposits at rates that are higher than average. The FDIC must take steps to shut down these banks if their equity capital amounts less than 2% of assets.

What are the FHA and CRA? How might they have played a role in the housing crisis?

The FHA was created to insure mortgage loans made by private firms to qualifying buyers; the FHA reduced down payment requirements, thus leading to mortgages with very low down payments and high default rates; the CRA imposed reporting requirements on commercial banks regarding the extent to which they lent funds back into the neighborhoods where they gathered deposits

What happened to the GSEs Fannie Mae and Freddie Mac?

The Fed and US Treasury propped up Fannie Mae and Freddie Mac after suffering substantial losses from their holdings of subprime mortgages. Then, in September 2008, they were put into conservatorship.

How did the Fed respond to the potential failures of the investment banks Bear Stearns, Lehman Brothers, and Merrill Lynch?

The Fed had to take over $30 billion of Bear Stearn's hard-to-value assets to broker the deal of JP Morgan purchasing them, but Lehman Brothers went bankrupt and Bank of America bought Merill Lynch for a deep discount. The Fed did not really intervene with the latter two

In what ways has Fed transparency changed in recent years?

The Fed has increased its autonomy by announcing a target inflation level as well as make efforts to enhance communication about timelines, targets, and intentions of monetary policy.

What is the standard story of the Great Recession, and what is Sumner's interpretation?

The Fed should've eased monetary policy sooner. The resulting Recession made the housing market worse, thus creating a huge banking crisis

What are the main requirements of the Truth in Lending Act and the Fair Credit Billing Act?

The Truth in Lending Act requires all lenders, not just banks, to provide information to consumers about the cost of borrowing, including the disclosure of a APR and the total finance charges on the loan. The Fair Credit Billing Act requires creditors, especially credit card issuers, to provide info on the method of assessing finance charges and requires that billing complaints be handled quickly.

According to Blinder, what are three things that must be admitted about the failure of Lehman Brothers?

The US Treasury shares the blame; It was unsure how much good collateral Lehman could have posted to secure Fed Reserve loans, but the Fed was the legal judge of it; The Fed and Treasury tried to strike a deal for someone to buy Lehman, but failed

What determines the shape of the supply curve in the market for reserves? In what case would it become infinitely elastic?

The amount of non-borrowed and borrowed reserves affect the shape of the supply curve; it would be infinitely elastic (flat) when the fed funds rate is hovering at the discount rate, since it can never rise above it.

Do the objections to the risk-taking channel of monetary policy mean that it would be better to use macroprudential supervision to constrain credit bubbles? What are some doubts on this score?

The argument would be quite strong if macroprudential policies were able to do the job; however, there are doubts about its ability. Prudential supervision is subject to more political pressure than monetary policy because it affects the bottom line of financial institutions more directly. Thus they have greater incentives to lobby politicians that would rein in credit bubbles, particularly during a credit bubble. Also, financial institutions are often very good at finding loopholes to avoid regulation and so macroprudential supervision may not be effective.

What is quantitative easing, and how was it used during the financial crisis?

The asset purchase programs where the Federal Reserve purchases assets, leading to an expansion of its balance sheet; In the financial crisis, the Fed set up a Government Sponsored Entities Purchase Program in which the Fed eventually purchased $1.25 trillion of mortgage-backed securities. Through this, the Fed hoped to prop up the mortgage backed security market and to lower interest rates on residential mortgages to stimulate the housing market.

In such a system, how do banks respond to changes in the public's demand for money?

The banks respond to a change in public's demand for money by expanding/contracting credit until equilibrium is restored.

What action should you take in regard to market manipulation?

The best way to protect yourself from the manipulators is to invest for the long term.

How is the structure of the European Central Bank different from the Federal Reserve System?

The budgets of the Fed Reserve Banks are controlled by the Board of Governors whereas the National Central Banks control their own budgets and the budget of the ECB in Frankfurt. Second, monetary operations are not centralized as they are in the Fed Reserve System.

How do open market operations affect reserves in the banking system? How is this reflected on the balance sheets of the Fed and the banking system?

The central banks purchase or sell securities in the open market, injecting reserves into the banking system; The result of the Fed's open market purchase is an expansion of the Fed's balance sheet with an increase in both its holdings of securities and reserves and vice versa-- the size of the banking system's balance sheet has not changed

What do Krugman and Wells think of financial innovation? What three relevant points they make?

The complexity of the financial structure spread the bust to financial institutions around the world; They did not understand the riskiness of subprime mortgages, the simplicity of European financial techniques were unable to prevent a huge bubble and bust, and the housing bubble was matched by a simultaneous bubble in commercial real estate, which is financed by old-fashioned bank lending.

What is the argument for having the central bank independent of politicians? How does the principal-agent problem illustrate this issue?

The control of monetary policy is too important to leave to politicians-- a group that has repeatedly demonstrated a lack of expertise at making hard decisions on issues of great economic importance; both the Fed Reserve and politicians are agents of the public (principals) and both the politicians and the Fed have incentives to act in their own interest rather than the interest of the public; the principal agent problem is worse for politicians than for the Fed because politicians have fewer incentives to act in the public interest.

Why might low interest rates by the Fed have led to a real estate bubble? What do Krugman and Wells think are serious problems with this view?

The cost to get loans for houses were lower due to lower rates, thus encouraging more people to buy houses with loans; Some problems are that the Fed had to keep interest rates low as well as the fact that the housing bubble was a North Atlantic rather than purely American phenomenon.

What are the main arguments against central bank independence?

The current lack of accountability leads to serious consequences; the Fed suffers no consequences if they perform badly--in some instances, its independence may encourage it to pursue a course of narrow self-interest rather than the public interest.

What are the dangers of overregulation?

The danger is that too much or poorly designed regulation could hamper the efficiency of the financial system and hinder economic growth

Why is moral hazard a prominent concern associated with government arrangements to provide safety nets?

The existence of this insurance provides increased incentives for taking risks that might result in an insurance payoff; with a safety net, depositors and creditors know they will not suffer losses if a financial institution fails, so they do not impose the discipline of the marketplace on these institutions by withdrawing funds when they suspect the institution is taking excessive risk

What are the discount window and the two main types of discount lending?

The facility at which banks can borrow reserves from the Federal Reserve is called the discount window; the two main types are primary credit, which plays the most important role in monetary policy, and secondary credit, which is given to banks that are in financial trouble and are experiencing severe liquidity problems.

What a characteristics of American politics prevented the creation of a central bank before 1913?

The fear of centralized power as well as the traditional American distrust of moneyed interests

According to Sumner, what is well understood, and about what is Bernanke right?

The first part of the housing bust is well understood, but it wasn't the problem-- Bernanke said that the losses were not enough to threaten the US banking system

How do aspects of central banking set the stage for the classical business cycle? How?

The fiscal advantages of central banking come at the cost of greater potential macroeconomic and financial instability because the privileges on which they are based also make it far more likely that domestic credit expansion will proceed beyond sustainable limits, with equilibrium being restored in the long run by means of an external drain of specie.

How were the politicians who founded the Federal Reserve able to design such a system?

The founders realized that the public would negatively react to a large, centralized bank--they decided to set up a decentralized system

When did the exchange write to Sarao and ask him to stop spoofing? When did regulators decide to have him arrested? Did he stop trading during that time? What did he do?

The futures exchange wrote to Sarao on the day of the flash crash, telling him to stop spoofing; regulators pondered that reply for five years before deciding that they'd prefer to have him arrested in London and extradited to face criminal spoofing charges; he allegedly continued to manipulate the futures market more or less up to the moment he was arrested

So then what, according to Sumner, caused the Great Recession?

The great NGDP crash of 08-09 caused a decline in RGDP-- this was caused by tight monetary policy

Why, according to Rajan, is the global savings glut only a partial explanation of the housing bubble and crisis?

The housing bubble was focused in the lower income segments of the market, unlike in the typical US housing boom—there must be a reason why foreign money gravitated towards the low income segment of the market

According to Krugman, why didn't financial stability bring a rapid bounceback?

The housing bubble was still a main issue and still hadn't recovered

What is the key principle to consider in designing policies to "lean against" credit bubbles? What is macroprudential regulation and how is it related to credit bubbles?

The key principle is to curb excessive risk taking. Macroprudential regulation is regulatory policy to affect what is happening in credit markets in the aggregate, and it does not seem to be the right tool for reigning in credit-driven bubbles.

How did adverse selection and principal-agent problems affect the mortgage market in the early 2000s? What compounded this problem?

The mortgage brokers that originated the loans did not make a strong effort to evaluate whether the borrower could pay off the loan, since they would quickly distribute the loans to investors in the form of mortgage-backed securities, leading to the principal-agent problem; As for adverse selection, risk-loving investors lined up to obtain loans to acquire houses that would be profitable if houses went up, knowing they could "walk away" if housing prices went down. Lax regulation of originators compounded the problem.

What is the most popular reason to bring back Glass-Steagall? How does this position go?

The most popular reason is to safeguard FDIC-insured deposits from being lost through risky activities-- i.e "ending taxpayer bailouts." Financial risk-taking is all well and good, but it should be done without the benefit of the FDIC's support, which is intended to protect only the quotidian business of ordinary banking.

What two primary methods does the FDIC use to handle a failed bank?

The payoff method, where the FDIC allows the bank to fail and pays off deposits up to the $250k insurance limit (with funds acquired from the insurance premiums paid by the banks that have bought FDIC insurance). After the bank is liquidated, the FDIC lines up with other creditors of the bank and is paid its share of the proceeds from the liquidated assets. The second method, the purchase and assumption method, is where the FDIC reorganizes the bank and finds a willing merger partner to assume all of the failed bank's liabilities (so that no depositor/creditor loses a penny).

How did debt deflation affect the price level and the unemployment rate in the 1930s?

The price level declined by 25%; the decline in net worth and increase in adverse selection and moral hazard led to an unemployment rate of 25%.

Mark-to-market accounting is subject to what major flaw? How does it happen?

The price of an asset sold at a time of financial distress does not reflect its fundamental value-- fire sale liquidation value of an asset can be well below the present value of its expected future cash flows

Why is the public hostile to inflation? How does it affect the economy?

The public is hostile to it because it leads to lower economic growth. In particular, it becomes more difficult to decide how much to save for a child's college education or other large purchases.

What determines the shape of the demand curve in the market for reserves?

The quantity of reserves demanded, holding everything else constant, as the federal funds rate changes will determine the shape of the demand curve.

What was the result of maintaining the problematic regulations of the state-chartered system?

The result was a series of ever-worsening banking panics, culminating in severe panics in 1893 and 1907. These panics were characterized by increases in demand for currency issued by national banks around harvest season when more currency was needed to buy and sell crops.

What changes can sow the seeds of a crisis? What can they prompt in the short run, and what eventually happens?

The seeds of a financial crisis are often sown when an economy introduces new types of loans or other financial products, known as financial innovation, or when countries engage in financial liberalization; in the short run, it can prompt financial institutions to go on a lending spree (credit boom); these credit booms eventually lead to overly risky lending.

How was the financial crisis like a run on the shadow banking system?

The sharp decline in the value of mortgages and other financial assets triggered a run on the shadow banking system, which is composed of hedge funds, investment banks, etc. These are not as tightly regulated as banks, and funds from these shadow banks flowed through the financial system and supported the issuance of low-interest-rate mortgages and auto loans. These securities were funded primarily by repurchase agreements, which used mortgage-backed assets as collateral. This decrease in collateral worth resulted in fire sales in order to allow the financial institutions to raise funds, resulting in a run on the banking system.

What are the three most important regional Fed banks? What percentage of the assets of the Federal Reserve System do they control? What about the top one?

The three largest Fed Reserve banks are those in New York, Chicago, and San Francisco, holding more than 50% of the assets. The top one, New York, holds about 25%

How did negotiations between politicians and bankers lead to the Federal Reserve System?

The two groups eventually settled on the Fed Reserve system as a "decentralized central bank". By carving the US into 12 districts and putting a regional bank in charge of each one, with all 12 coordinated by a weak oversight board in DC, the hope was to diffuse political opposition.

How did declining housing prices and rising defaults affect banks' balance sheets?

The values of mortgage-backed securities and CDO's collapsed, leaving banks and other financial institutions with a lower value of assets and thus a decline in net worth

What is the first problem with this narrative, and what was the result?

There has never been a time when banking was unregulated; the result was an unsatisfactory banking system: banks were too few in number, their assets were insufficiently diversified, and they were often run by people who knew little about the business but knew the right people.

How are economic growth and employment related to price stability in the long and short runs?

There is no long-run trade-off between inflation and employment. In the long run, price stability promotes economic growth as well as financial and interest-rate stability; In the short run, price stability often conflicts with the goals of high employment and interest-rate stability.

What was the leverage cycle prior to the financial crisis? How can macroprudential policies short-circuit this leverage cycle?

There was a feedback loop from a boom in issuing credit, which led to higher asset prices, which resulted in higher capital buffers at financial institutions, which supported further lending in the context of unchanging capital requirements, raising asset prices further. Macroprudential policies made capital requirements countercyclical-- they would be adjusted upward during a boom and upward during a bust. Also, during the upward swing of the cycle, these policies force financial institutions to tighten credit standards or limits on growth of credit.

According to White, what didn't happen in the crisis?

There was no deregulation; greed did not cause the mess—it has always been present

What forces led to low interest rates on residential mortgages in the early 2000s?

There were huge capital inflows into the US from countries like China and India; Secondly, congressional legislation encouraged Fannie Mae and Freddie Mac to purchase trillions of dollars of mortgage-backed securities. Third was the easy Fed Reserve monetary policy to lower interest rates

How did credit ratings agencies contribute to (rather than reduce) asymmetric information?

These agencies did not have any special incentives to accurately rate products-- This resulted in inflated ratings caused investors to be unaware of the exact risk they were buying

How are taxpayers at risk? What would Glass-Steagall do (and not do)?

They are at risk because their government cannot credibly promise not to stave off financial apocalypse if it has the power to do so. Glass-Steagall would not change this dynamic.

What are stress testing and value-at-risk calculations?

They are formal risk management policies and procedures put into place to ensure that the board of directors' risk limits are not violated and help implement internal controls to monitor interest rate risk; stress testing calculates losses under dire scenarios while VAR calculations measure the size of the loss on a trading portfolio that might happen 1% of the time

What are calls for a "new Glass-Steagall" really about? How is its repeal presented?

They are simply about political posturing; its repeal is presented as a morality tale in which the forces of "maniacal deregulation" cleared away the venerable New Deal law in pursuit of filthy lucre and as a consequence, brought us the financial crisis

How can bankers avoid complex regulations? How can loopholes be eliminated?

They can manipulate complex regulations (ex: tax loophole); reducing regulatory complexity can help eliminate loopholes and stabilize the financial system.

What are "reserves"? For whom are they assets or liabilities?

They consist of deposits at the Fed plus currency that is physically held by banks. They are assets for banks but liabilities for the Fed

What role did the Federal Reserve play in the stock market crash of 1929 and the bank panics that followed the stock market decline in November and December of 1930?

They curbed the stock market boom by tightening monetary policy to raise interest rates to limit the rise in stock prices, but the stock market shortly crashed; in 1930, when farmers became unable to pay back their bank loans which resulted in several defaults on farm mortgages, the Fed sat idly and did nothing.

How can central bankers focus on reducing output fluctuations? On what does the choice of mandate for a central banker ultimately depend?

They do it by allowing inflation to deviate from the long run goal for short periods. It ultimately depends on the subtleties of how the mandate will work in practice.

What about Canada do critics of the laissez-faire system ignore? How was it different than the US in the 1920s and 1930s?

They ignore the success story of Canada, whose banking system was much less regulated than that of the US. This was different from the US, where almost 10,000 banks failed during the great depression-- in Canada, no banks failed after 1929 due to their higher degree of geographic diversification, which led to less risky portfolios. They were able to escape the worse effects of the Great Depression because its banks were less regulated and its lack of a central bank meant that it avoided the artificial boom of the 1920s and the severe deflation of the 1930's.

How do government safety nets such as deposit insurance affect risk taking during a credit boom? What happens if loans are repaid or default?

They increase the moral hazard incentive for banks to take on greater risk than they otherwise would; lender-savers will supply undisciplined banks with funds since there is insurance to protect losses; IF loans are repaid, banks will walk away with nice profits; if they default, the bank will get back government deposit insurance from the taxpayers.

What were the serious disadvantages of restrictions on competition that propped up the health of US banks?

They led to higher charges to consumers and decreased the efficiency of banking institutions, which did not have to compete as vigorously. Thus, although the existence of asymmetric info provided a rationale for anticompetitive regulations, it did not mean that they would be beneficial.

How did the Fed expand the discount window during the financial crisis? What were the effect?

They lowered the discount rate to 50 basis points above the federal funds rate target from the normal 100 basis points. It was then lowered again in March. The effect was that borrowing from the discount window has a stigma because it suggests that the borrowing bank may be desperate for funds.

How often does the Federal Open Market Committee meet, and what policy does it set? How does this affect the stance of monetary policy?

They meet 8 times a year. They decide the federal funds rate. The effect of these actions is it either eases or tightens the monetary policy

What do theoretical treatments of central banking almost exclusively emphasize?

They place an exclusive emphasis on its stabilizing capacity-- on central banks' role in managing the growth of national monetary supplies and in supplying last-resort loans

What are hierarchical mandates for central banks? Give an example.

They put the goal of price stability first and then say that after it is achieved other goals can be pursued. These include directors governing the behavior of central banks such as the Bank of England or the Bank of Canada.

What pressure did Congress and HUD put on Fannie Mae and Freddie Mac? What role did the Treasury play?

They required the GSE's to devote a large percentage of their activities to meeting affordable housing goals; The US Treasury backed these

What new evidence does Bernanke provide regarding the two potential channels by which the crisis affected the economy? What results does he find?

They show that the severity of the recession cannot be explained by a deterioration in housing and consumer finances alone and that policymakers' actions helped prevent an even more devastating blow to Main Street; the financial panic caused the recession, not just the housing bubble

What do Krugman and Wells think were the main causes of the bubble? What were the effects of regulation and securitization?

They think the global savings glut caused the bubble—financial innovations helped inflate the bubble; The failure of the Fed to regulate made things worse as well as securitization—the mess was harder to clean up

What are some reasons that central banks should not try to pop asset-price bubbles?

They're nearly impossible to identify, raising interest rates may be very ineffective, an asset bubble may be present in only a fraction of the specific assets, monetary policy to pop bubbles can harm overall economy

What were some of the Fed's new lending programs created during the financial crisis, and what were their effects?

This included lending to investment banks as well as lending to promote purchases of commercial paper, mortgage-backed securities, and other asset-backed securities. It also lended to JP Morgan to assist in its purchases of Bear Stearns and AIG to prevent its failure; The effects were that it expanded the Fed's balance sheet by over $1 trillion and with the balance-sheet expansion continuing afterward.

What is a "sequential service constraint"? How does it combine with asymmetric information to cause bank runs?

This is a "first-come, first serve" format that describes how banks operate; Because of asymmetric information, depositors are unable to tell whether their bank is a good or bad bank--they are inclined to "run" to the bank when uncertainty is prevalent in hopes of getting their deposits back without losing anything.

What is the Dodd-Frank Act? How comprehensive is it?

This is a bill that created a new regulatory structure in response to the global financial crisis to make a repeat of the crisis less likely. It was passed in July of 2010; it is the most comprehensive financial reform legislation since the Great Depression.

What is the "principle of adverse clearings"?

This is a competitive check against the over-issuance of bank money. Because of it, the total volume of money and credit in a free banking system cannot easily expand beyond limits consistent with a stable overall volume of payments.

What is a CAMELS rating? What happens if the CAMELS rating is sufficiently low?

This is a rating that bank examiners give banks that accounts for a banks compliance with capital requirements and restrictions on asset holdings; It incorporates Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to market risk; If the rating is sufficiently low, regulators can enforce regulations by taking formal actions such as cease and desist orders to alter the bank's behavior or close the bank.

What is forward guidance, and how is it used to affect monetary policy?

This is a route taken by Fed to lower long-term interest rates; it involves a commitment by the Fed to keep the federal funds rate at zero for a long period of time in order to lower the market's expectations of future short-term interest rates, causing long-term interest rates to fall; this commitment led to monetary policy that was too easy for too long, with inflation rising to well above desirable levels-- it may have helped promote the housing bubble

If central banks are sources of instability, why are they regarded as just the opposite?

This is partly due to modern economists' limited understanding of the workings of competitive currency arrangements which causes them to assume that such arrangements must be less stable than monopolistic ones (because less are subject to central control) and also due to their failure to appreciate the origins of the idea that monetary systems require a "lender of last resort."

What is debt deflation? Explain in your own words.

This is stage 3 of a financial crisis, where the overall level of debt is rising in real value due to deflation-- people's net worth significantly decrease due to a decrease in asset value, but the value of their debt stays the same--they will still have to pay back the original price they paid before the crisis, resulting in even more defaults and insolvency.

How might negative interest rates on deposits be used by central banks to affect monetary policy? Why might this policy not have the intended effect.

This is supposed to encourage households and businesses to spend more. They might not have the intended effect because charging banks interest on their deposits might be very costly to banks if they still have to pay positive interest rates to their depositors.

What is the too-big-to-fail problem? What was the role of the bank Continental Illinois?

This is the moral hazard created by a government safety net and the desire to prevent financial institution failures; it occurs when regulators are reluctant to close down large financial institutions and impose losses on the institutions depositors and creditors because doing so might precipitate a financial crisis; the Continental Illinois bank went insolvent in May of 1984, but the FDIC guaranteed depositors up to the $100k limit (at the time) and this set a precursor for future insolvencies of the biggest banks.

What was the Emergency Economic Stabilization Act? How did the market respond?

This occurred when the House of Representatives voted down a $700 billion bailout package proposed by the bush administration. The stock market crash accelerated, showing the worst weekly decline in US history. Credit spreads went through the roof over the next few weeks as well.

What is discount lending? How does is affect reserves and the balance sheets of the Fed and the banking system?

This occurs when the Fed banks a discount loan to a bank; a discount loan leads to an expansion of reserves, which can be lent out, thereby leading to an expansion of liquidity in the banking system; when a bank repays its discount loan and so reduces the total amount of discount lending, the amount of reserves decreases along with liquidity in the banking system

How do banks in a free banking system return them to their sources for redemption? What does this mean?

This practice of "clearing" involves the practice of exchanging notes with banks returning rivals' notes directly to them or to central clearinghouses and settling accounts in specie. This imposed strict limits on credit expansion by individual note-issuing banks and created a tight connection between those limits and the available supply of specie reserves.

What does the study by the Federal Reserve Bank of New York (cited in the Fed's rule-making proposal) find regarding the effectiveness of capital and RBC ratios?

This study found out that in a short time horizon, risk weighting can overstate differences in asset returns and reduce accuracy of risk-weighed ratios

What is wash trading?

This tricky form of manipulation is when a big player buys and sells the same security continually and nearly instantaneously. The rapid buying and selling pumps up the volume in the stock, attracting investors who are fooled by the spiking volume.

Did problems in the pre-Fed system reflect a failure of "laissez-faire"? Why or why not?

This was not a failure--the fed gov still played a role even in absence of a central bank; The problems with the US banking system were due to poorly planned regulations

What is the Term Auction Facility? How was it used in the financial crisis?

This was setup to encourage additional borrowing; it made loans at a rate determined through competitive auctions. The TAF auctions started at amounts of $20 billion, but as the crisis worsened, the Fed raised the amounts dramatically, with a total understanding of over $400 billion.

Why does it matter that central banks are exempt from the principle of adverse clearings?

This will allow the central bank to operate on a slim cushion of specie reserves, with a greater "leveraging" of central-bank capital. Also, it will be able to expand credit and increase the supply of commercial bank's reserves without having to fear any immediate internal drain of precious metal from its own coffers.

What, according to White, is the traditional remedy for financial firms that make bad investments? What is the long-term remedy for mistaken government policy?

To shut and dismantle those firms to stop the bleeding, free their assets and personnel to go where they can add value, and make room for firms with better ideas; the long term remedy is to identify and undo policies that distort housing and financial markets and to dismantle failed agencies.

Why doesn't insider information guarantee outcomes?

Trading on insider information gives you some information, but without another critical piece- how will other market participants react; someone always has an advantage, whether it be faster computers, better algorithms, etc.

Why do bank runs lead to bank panics? What is the contagion effect?

Uncertainty about the health of the banking system can lead to runs on both good and bad banks, and the failure of one bank can hasten the failure of others (known as the contagion effect); if nothing is done to restore the public's confidence, a bank panic can ensue.

What are two reasons that financial regulation and supervision are difficult?

Unless regulators get the regulation and supervision just right, they may be unable to prevent excessive risk taking. Also, regulated firms may lobby politicians to lean on regulators and supervisors to go easy on them.

What are some duties of the Consumer Financial Protection Bureau? [FYI: Despite what the book says, not all of these reforms are in the CFPB's jurisdiction.]

Verifies income, credit history, and job status; it bans payments to brokers for pushing borrowers into higher-priced loans; It permanently increased level of FDIC to $250k.

How do government-imposed capital ratios minimize moral hazard at financial institutions?

When a financial institution is forced to hold a large amount of equity capital, the institution has more to lose if it fails and is thus more likely to pursue less risky activities.

What role did Greece and Greek bonds play in the European sovereign debt crisis?

When a new government was elected in October, it revealed that their budget situation was far worse than imagined, due to the misleading numbers given by previous government. The budget deficit was double the original 6% and the amount of debt was severely understated. In response, interest rates on Greek debt soared to nearly 40% and net debt-to-GDP climbed to 160% of GDP in 2012. Other countries helped bail out Greece, but they were forced to write down the value of its debt held in private hands by more than half, resulting in civil unrest. This spread to many other European countries.

How does bursting an asset price bubble lead to moral hazard and tighter lending standards?

When an asset price bubble bursts, stock and real estate prices tumble, and companies see their net worth decline. The value of collateral they can pledge drops, meaning that these companies now have less "skin in the game" and are more likely to make risky investments because they have less to lose. As a result, financial institutions tighten lending standards for borrow-spenders.

How does rate of interest on reserves affect the fed funds rate and the quantity of reserves?

When the federal funds rate is at the interest rate paid on reserves, a rise in the interest rate on reserves raises the federal funds rate; a fall in the interest rate paid on reserves lowers the federal funds rate.

What is the time-inconsistency problem? Why does it matter in monetary policy?

Where monetary policy conducted on a discretionary, day to day basis leads to poor long-term outlooks. AKA, it is hard to follow a good plan over time, so the plan is deemed time-inconsistent. Important because policy makers will want to explore expansionary policy for short term benefits, need to stay focused on the long-term.

What two questions does Blinder raise regarding the Fed's exit strategy?

Why does the FOMC's announced sequencing seem destined to steepen the yield curve? The timing of tapering has no bearing on the timing of the eventual increases in the funds rate

Is it a problem to have dozens of capital and liquidity regulations? How will this affect banks' holdings of risky assets?

Yes, because many of them overlap and are contradictory; US capital regulations encourage banks to hold fewer risky assets (like Mortgage backed securities) and more moderate-risk real estate loans. Liquidity ratios, however, require banks to hold safe, liquid assets like treasury bonds, meaning that banks must also hold risky MBS in order to earn the same overall rate of return--these are conflicting regulations

Does the US case contradict the claim that central banks are destabilizing institutions? Why or Why not? What does the US case represent?

Yes, since the US experienced financial crises even before they decided to embrace central banking. The case represents a special instance of the general pattern according to which central banking emerged as an unintended by-product of fiscally motivated government interference with the free development of national financial institutions.

Will large bank reserves stimulate the economy and produce inflation down the road? What are reasons to be skeptical?

Yes, the increase in reserves increases liquidity in the banking system, enabling banks to lend more, making it a powerful force that could stimulate the economy and possibly produce inflation down the road; There are reasons to be skeptical, because the federal funds rate had already hit the zero-lower-bound when it fell to zero, the expansion of the balance sheet and the monetary base could not lower short-term rates any further; also, the increase in reserves did not result in an increase in lending because banks just added to their holdings of excess reserves instead of making loans.

Is it possible that Sarao didn't cause the flash crash? When was his algorithm on, and when did the crash occur?

Yes; The flash crash happened when Sarao's algorithm had been turned off

Has QE worked according to Blinder? Are there other options?

Yes; other options include lowering the interest rate the Fed pays on excess reserves (into possibly negative territory)

What is Libor?

t's the London interbank offer rate, an interest-rate benchmark for many other rates, from commercial loans to mortgages. Libor is also an important index for derivatives, which are complex agreements whose value derives from a benchmark; It is also the most widely used interest rate in the world

Does Blinder think regulators' stress testing program was successful? Why or why not?

yes; after the stress test results came back, financial markets bounced back quickly