MAB Ch. 13-20
Consider an economy in which banks hold $25 billion in aggregate reserves (composed of $20 billion deposit in the Federal Reserve and $5 billion in bank vaults), while the public holds $10 billion in cash. The monetary base in this economy equals
$35 billion.
If required reserves are expressed by RR, the required reserve rate by rD, and deposits by D, the simple deposit expansion multiplier is expressed as
1/rD.
If growth in the money supply is 3%, inflation is 2.5%, and velocity increases by 1.5%, then according to the equation of exchange real growth must equal
2%. (3% + 1.5% = 2.5% + real growth)
Suppose the natural rate of interest in an economy is 4%. If current inflation is 3% while the inflation target is at 1% and there is an output gap of 1% as well, according to the Taylor rule, the target federal funds rate should be ______.
8.5% (4% + 3% + 1/2(3% - 1%) + 1/2(1%) = 8.5%.)
All else equal, which of the following would increase the supply of money?
A decrease in the currency-to-deposit ratio.
What is the difference between solvency and liquidity for a bank?
A solvent bank has a positive net worth while a bank with liquidity means that the bank has sufficient reserves and immediately marketable assets to meet withdrawal demands.
Which of the following is true about commercial bank membership in the Federal Reserve System (the Fed)?
All nationally-chartered banks belong to the Fed.
Evaluate the following statements about the accountability and transparency in the European Central Bank versus the Federal Reserve System. Which of the following are NOT true?
All public ECB materials are available only in English. The ECB issues minutes more quickly. There is evidence that the ECB's communication policies are working poorly.
The Board of Governors conducts which of the following?
Approving or denying bank mergers Supervising and regulating Reserve Banks Setting reserve requirements
Indicate which of the following is NOT true about the European Central Bank and the euro?
As of 2010, the euro was the currency of only twelve nations. The European Central Bank was created after the formation of the European Union. All countries in the euro area also use their own original currencies.
A customer of Bank A writes a $20,000 check for a new car, which the car dealer deposits in his bank, Bank B. How does this transaction change reserves at Bank A and Bank B?
Bank A's reserves decrease by $20,000 and Bank B's reserves increase by $20,000.
When the Federal Reserve buys $5 million in U.S. government bonds from Bank Y
Bank Y alone can now create $5 million more in new money.
Compare and contrast the structures of bank holding companies, financial holding companies and universal banks.
Bank holding companies Correct typically own several banks. Financial holding companies Correct own banks and other financial intermediaries (such as investment banks and insurance companies). In bank holding companies and financial holding companies Correct, there usually remain legal and regulatory separations among the subsidiaries. Universal banks Correct own a variety of intermediaries (with fewer legal and regulatory separations compared to financial holding companies) as well as non-financial firms.
Explain how a bank run can turn into a bank panic.
Bank runs occur when people fear that their bank has become insolvent Correct. Depositors rush to their bank to withdraw their funds. Depositors at other banks become concerned about their own bank's solvency Correct, so they also hurry to withdraw their funds. Bank runs can turn into system-wide bank panics because customers have a difficult time distinguishing insolvent Correctbanks from solvent Correctones.
Which of the following is true about bank reserves?
Both required reserves and excess reserves are liabilities for the central bank.
Which of the following is not one of the most important day-to-day activities of a central bank today?
Buying and selling foreign currency
Which of the following does not describe an action taken by the Federal Reserve since the 1930s?
Causing its balance sheet to shrink to unprecedented proportions
The liabilities side of the central bank's balance sheet can be divided into which three categories?
Currency, government deposit accounts, and commercial bank deposit accounts
Which of the following is NOT true about exiting these types of unconventional policy?
During exit the central bank will need to increase its asset holdings. Exiting must cause inflation rates to rise. The central bank will need to increase the supply of reserves to exit.
Which of the following is true about historical events over the last fifty years and their effects on velocity and related variables?
Financial innovations like mutual funds tend to increase velocity.
Which of the following is true about the Board of Governors of the Federal Reserve System?
Governors serve fourteen-year terms.
European economic problems in the twentieth century led to the decision to form the European monetary union and the European Central Bank. Which of the following was one of those problems?
High fiscal deficits
Central banks aim for stability throughout the nation in several areas. Which of the following is not one of those areas?
Human capital
Policymakers in open economies face a "trilemma" of three conditions that cannot all be realized at the same time. Which one of the following is not part of this "trilemma" of open-economy macroeconomics?
Implement capital controls.
Which of the following is not a potential benefit of a fixed exchange rate system?
Increased control over domestic monetary policy
Exiting is a key issue with target asset purchases and quantitative easing. Which of the following is true about exiting these types of unconventional policy?
Increasing the interest rate paid on reserves may ease the transition.
Which of the following statements is NOT considered a major difficulty with the use of quantitative easing?
It has been overused throughout time. It tends to decrease policymakers' credibility. The federal funds rate will go negative.
Which of the following is not a potential cost of a fixed exchange rate system?
Less credibility of central bank promises to keep inflation low
Explain why financial institutions such as pension funds and insurance companies are not as vulnerable to runs as money market mutual funds and securities dealers.
Like deposit-taking institutions, money market mutual funds and securities dealers have liquid Correct liabilities backing illiquid Correct assets and can suffer from a loss of liquidity Correct similar to a deposit withdrawal from a bank at any time. In contrast, liability holders of pension funds and insurance companies cannot Correct withdraw funds whenever they want. Therefore, even though their assets tend to be illiquid Correct, they are not as vulnerable to runs.
The equation of exchange is written as MV = PY. Which of the following accurately defines variables appearing in this equation?
M is the money supply and Y is real GDP.
Which of the following is the least effect policy tool at the Fed's disposal?
Reserve requirements
Which of the following is an objective for the Federal Reserve as set out by Congress?
Stable prices Moderate long-term interest rates Maximum employment
Which of the following is a major similarity between the European Central Bank and the Federal Reserve System?
The ECB uses interest rates to control the availability of money and credit.
Determine which of the following statements is true about the mandates of the Federal Reserve System and the European Central Bank?
The ECB's top objective is price stability. The Fed's mandate is written in overall more vague terms than the ECB's. The ECB numerically defines what it considers price stability.
Indicate which of the following is true about the European Central Bank and the euro?
The Treaty of Maastricht led to the creation of the European monetary union.
Which of the following is consistent with a bank panic?
The amount of loans available will decrease. Businesses will find it harder to get funding. Economic growth will likely slow.
Which of the following is true about the central bank?
The central bank can control money and credit because it can print currency.
Which of the following is NOT true when the central bank engages in quantitative easing?
The central bank's balance sheet will shrink. The central bank loses bonds on its balance sheet. It increases aggregate reserves just shy of the level needed for the central bank's interest rate target.
Which of the following is not, at least in part, under the central bank's control?
The government budget
Regulators have traditionally required banks to maintain capital-asset ratios of a certain level to ensure adequate net worth based on the size and composition of the bank's assets on its balance sheet. Why might such capital adequacy requirements not be effective?
The importance of off-balance sheet activities has been increasing and the nature of these activities facilitates a high level of risk taking by banks that is not apparent from the institution's balance sheet.
Use your knowledge of the problems associated with asymmetric information to explain why insurance companies often include deductibles as part of their policies.
The presence of deductibles helps to reduce moral hazard. In the case of car insurance, for example, the insured faces a cost associated with an accident and so will likely be more careful when driving.
Suppose demand for money is stable and the central bank increases the money supply substantially.
The price of money falls Inflation results
In the absence of limits on the behavior of large intermediaries, how might the perception of institutions being "too-big-to-fail" lead to increased concentration in the banking industry?
The safety net creates moral hazard problems for big banks by encouraging extremely risky behavior. This puts small banks at a competitive disadvantage, driving them out of the market and leading to an increase in concentration
Why has the number of banks in the United States fallen steadily in the past three decades?
There has been a trend toward consolidation in the banking industry.
Which of the following are NOT true about the Federal Reserve Banks? (Check all that apply.)
They are led only by the Board of Governors. They take deposits from the general public. The 2007-2009 financial crisis led some to think the Reserve Banks were too hard on financial intermediaries.
Which of the following is not true about currency boards?
They provide an example of dollarization.
Prior to the Civil War most state banks issued their own banknotes. Which one of the following is not true about these banknotes?
They were usually redeemable in gold.
Statistically, teenage drivers are more likely to have an automobile accident than adult drivers. As a result, insurance companies charge higher insurance premiums for teenage drivers. Suppose one insurance company decided to charge teenagers and adults the same premium based on the average risk of an accident among both groups. Using your knowledge of the problems associated with asymmetric information, explain whether you think this insurance company will be profitable.
This insurance company is unlikely Correct to be profitable because of the problem of adverse selection Correct. The insurance premium based on the average risk of an accident among both teenagers and adults will be higher Correct than the premium for adults alone and lower Correct than the premium for teenagers alone. Therefore, adults Correct will not choose to be insured by this company but teenagers Correct will. The premium charged based on the average risk of teenagers and adults would not Correct be sufficient to cover the claims of a teenage-only Correct pool and so the company would not Correct be profitable.
Suppose that male drivers are more likely to have an automobile accident than female drivers. As a result, insurance companies charge higher insurance premiums for male drivers. Suppose one insurance company decided to charge male drivers and female drivers the same premium based on the average risk of an accident among both groups. Using your knowledge of the problems associated with asymmetric information, explain whether you think this insurance company will be profitable
This insurance company is unlikely Correctto be profitable because of the problem of adverse selection Correct. The insurance premium based on the average risk of an accident among both male and female drivers will be higher Correct than the premium for female drivers alone and lower Correct than the premium for male drivers alone. Therefore, female Correct drivers will not choose to be insured by this company but male Correct drivers will. The premium charged based on the average risk of male and female drivers would not Correct be sufficient to cover the claims of a male-only Correct driver pool and so the company would not Correct be profitable.
Which of the following is true about the two types of demand for money?
Transactions demand for money is related to its means-of-payment function.
Deflation is the rate of decline in the aggregate price level. Why might unexpected deflation be of particular concern to someone managing a bank?
Unexpected deflation is associated with falling Correct net worth of borrowers, as the nominal value of their assets falls Correct but the dollar amount of their liabilities remains the same Correct. This weakens creditworthiness and can lead to reduced Correct lending as asymmetric information problems worsen. In turn, reduced Correct credit supply can diminish economic activity, leading to increased Correct defaults, a deterioration in the quality of the bank's balance sheet and ultimately to bank insolvency.
Which of the following is true about hyperinflation?
When hyperinflation occurs, money no longer acts as a reliable store of value.
Evaluate the following statements. In which of them would we expect portfolio demand for money to decrease?
When the return on stocks and bonds rises When the liquidity of alternative investments rises When wealth decreases
In which of the following cases would portfolio demand for money not decrease?
When we expect interest rates to rise in the future
In the aftermath of the financial crisis of 2007-2009, there were calls to reinstate the separation of commercial and investment banking activities that were removed with the repeal of the Glass-Steagall Act, but this did not happen. Is there any benefit to segmenting financial activities if the goal is to lower systemic risk?
Yes. This type of separation may serve to remove some conflicts of interest for banks across their different activities and may protect against excessive risk taking with depositors' funds
The United States would be characterized as having
a controlled domestic interest rate, an open capital market, and a flexible exchange rate.
The text describes a spectrum of government involvement in exchange rates. At one extreme is a system of fully-flexible, market-determined exchange rates. The most extreme choice in the opposite direction would be
a hard peg.
Vault cash is
a liability that is part of reserves.
The Financial Crisis of 2007-08 occurred in three distinct phases which, in the order of occurrence, are
a liquidity crisis, a solvency crisis, and a recapitalization of the system.
When we compare the relationship between the opportunity cost of holding money and velocity in the 1980s with their relationship in the 1990s, both periods exhibit
a positive relationship, with a bigger increase in velocity from a given increase in the opportunity cost in the 1990s.
Policymakers can translate changes in money growth into changes into inflation when there is
a predictable relationship between the quantity of money and inflation.
Keeping interest rates stable is
a secondary goal for central banks.
The financial system is inherently more unstable than most other industries due to the fact that
a single firm failing in banking can bring down the entire system unlike in most other industries.
Monetary policy and fiscal policy are conducted by different entities. While their goals are the same, it is possible that
a successful monetary policy can counteract a successful fiscal policy
The interest rate on primary credit extended by the Fed is
above the IOER.
A liability of the central bank in functioning as the bankers' bank is
accounts of commercial banks.
It is impossible to have high and lasting inflation without
action by the central bank.
When the central bank engages in quantitative easing,
adding to reserves will not change the federal funds rate.
Interest rate volatility is a problem because it
adds to uncertainty, thereby diminishing an investment.
The assumptions and observations in the textbook imply that doubling income in nominal terms, all else equal, will result in the money supply
also doubling.
Consider a $2 billion open market purchase of U.S. Treasury securities by the Federal Reserve. The Fed's balance sheet will show
an increase in the asset category of securities and the liability category of reserves by $2 billion.
In a world where reserves are scarce, the impact on the foreign exchange market for dollars resulting from the Fed selling euros in an unsterilized intervention will be
an increase in the demand for dollars.
If the required reserve rate is ten percent and banks do not hold any excess reserves and there are no changes in currency holdings, a $1 million open market purchase by the Fed will result in which change in loans?
an increase of $10 million
Which of the following combinations each has the same impact on the Fed's balance sheet?
an open market purchase and an increase in loans by the Fed to banks
Since 2012, what does the ECB frequently use to inject reserves into the banking systems of countries that use the euro?
an outright purchase of securities
A major difference between the European Central Bank's refinancing operations and the Federal Reserve's open market operations is that refinance operations
are done at all National Central Banks at the same time.
Reserves are
assets of commercial banks and liabilities of the central bank.
Discount loans are
backed by bank collateral. requested by commercial banks.
Reserve demand becomes horizontal at the IOER rate because
banks will not make loans at less than the IOER rate.
If the Fed desired to fix the euro/dollar exchange rate, they would have to
be willing to exchange dollars for euros whenever anyone asked.
Deflation causes financial disruption when
borrowers have invested in real assets whose value declines while loan payments stay the same.
If capital flows freely between countries and a country has a fixed exchange rate, one thing you know is that the country
cannot have a discretionary monetary policy.
Milton Friedman recommended a _________ monetary growth rate based on the assumption that velocity is unchanging; this incorrect assumption could lead to major problems in nations where inflation is generally _______ 10%.
constant; below
Prior to the creation of the Federal Reserve System in the United States, how did financial panics typically begin?
crop failure or a bumper crop that drove the market price down
The monetary base is the sum of
currency in the hands of the public and reserves in the banking system.
If people lose faith in financial institutions, savers will _______ lending and economic investors will _______ borrowing.
decrease; decrease
Transactions demand for money
decreases as the liquidity of financial assets rises.
All else equal, when banks hold more excess reserves an economy's ability to expand deposits __________; when the public holds less cash an economy's ability to expand deposits _________.
decreases; increases
Rumors of a bank failing, even if not true, can become a self-fulfilling prophecy because
depositors will rush to the bank to withdraw their deposits and the bank under normal conditions would not have sufficient liquid assets on hand.
Eurodollars are
dollar-denominated deposits in banks outside the United States.
The demand for reserves curve is
downward sloping until the market federal funds rate equals the deposit rate and then becomes flat.
The Taylor rule implies that
each 2% increase in the output gap results in a 1% increase in the target federal funds rate.
Policy responses were critical in arresting the Financial Crisis of 2007-08 and promoting recovery. The responses used include all of the following except which one?
elimination of interest rate floors
Exchange rate stability is likely to be a more important goal for the central banks of
emerging market economies than the central bank of the United States.
Until 2008, the Fed could make the market federal funds rate equal the target rate by
entering the federal funds market as a borrower or a lender.
Contagion is the
failure of one bank spreading to other banks through depositors withdrawing of funds.
As a portion of total assets measured in billions of dollars, the smallest asset on the Fed's balance sheet is
gold.
A speculative attack on a country with a fixed exchange rate often occurs when financial market participants believe the
government will have to devalue its currency.
The United States has many banks because
historically, many states outlawed bank branching.
The text states that the main job of the central bank is to
improve economic welfare by managing risk.
The Federal Deposit Insurance Corporation (FDIC) was created
in 1933 as a part of the Glass-Steagall Act
Possible explanations for data indicating unstable money demand from 1979 to 2009 in the United States include
increased demand for money when mortgages were refinanced.
In order to employ a quantitative approach to the demand for money, analysts look at
interest rates. nominal income.
Transactions demand for money
is affected by technology.
During a bank crisis,
it is important for regulators to be able to distinguish insolvent from illiquid banks.
A crucial function of the Fed is to maintain a sound financial system by making loans even when no one else can. In this capacity, the Fed acts as a _____.
lender of last resort
A central bank's credibility is particularly important when it comes to the goal of ________, because _______________.
low inflation; many economic decisions are based on expectations about future prices
In the 1970s _____ central banks targeted money supply growth; today almost __________ do.
many; none
If prices are not stable,
money becomes less useful as a store of value.
The single most important fact in monetary economics is the relationship between
money growth and inflation rates.
In its percentage change form, equation of exchange does NOT tell us that
money growth plus inflation equals velocity growth plus real growth. inflation minus money growth equals real growth plus velocity. money growth minus velocity growth equals inflation minus real growth.
In its percentage change form, equation of exchange tells us that
money growth plus velocity growth equals inflation plus real growth.
As a bank for the government, the central bank can create _______; today it generally does this by _______.
money; adjusting interest rates
When compared to Canada or Japan, the United States is unusual in that it has
more banks than either Japan or Canada.
In the early years of the Great Depression, 1929-1933,
more than a third of all U.S. banks failed.
The equation of exchange tells us that the velocity of money
multiplied by the quantity of money equals nominal GDP.
If the Federal Reserve wants to fix the exchange rate between dollars and yen, it
must buy and sell dollars at a fixed rate.
If the current market federal funds rate equals the target rate and the demand for reserves increases, the likely response in the federal funds market will be
no change; reserve supply is so high that the market federal funds rate will be unchanged.
Buying and selling U.S. Treasury Securities for the Fed's own portfolio is called
open market operations.
Sustainable growth refers to growth in
potential output from growth in inputs.
In the equation of exchange, nominal GDP is given by
price level times the quantity of output.
The primary objective of most central banks in industrialized economies is
price stability.
How does the FOMC increase its transparency?
public speeches. publication of the "beige book." transcripts of meetings released after a lag.
If the market federal funds rate were below the target rate, the response from the Fed would likely be to
raise the IOER (interest rate on excess reserves).
When we transform the equation of exchange into its percentage change form, we are able to evaluate
real growth instead of real output. inflation instead of the price level. money growth instead of the quantity of money. velocity growth instead of velocity.
Consider a nation that experienced money growth of 2.5%, inflation of 1%, and an increase in the velocity of money of 3.5%. From this information we can calculate
real growth to be 5%.
The Gramm-Leach-Bliley Act
repealed the Glass-Steagall Act's prohibition of mergers between commercial banks and insurance or securities firms.
The Dodd-Frank does all of the following except
repeals the Glass-Steagall Act of 1933.
The Glass-Steagall Act of 1933
required commercial banks to sell off their investment banking operations.
As interest rates fall, the demand for money
rises and velocity falls.
A U.S. resident purchases a bond issued by the Canadian government. If the Canadian dollar appreciates relative to the U.S. dollar over the term of the bond, the U.S. investor will
see a higher return on her investment as a result.
During the financial crisis of 2007-2009 in the United States it was revealed that the function of a lender of last resort had not kept pace with the evolving financial system because
shadow banks lacked access to the financial resources available through the lender of last resort.
Primary credit extended by the Fed is
short-term, usually overnight loans.
The Fed is reluctant to change the required reserve rate because
small changes in the required reserve rate can have too big of an impact on the money multiplier and the level of deposits.
The text discusses occasions where nations at war counterfeited their opponents' currency to illustrate the importance of __________ in a healthy economy.
stable prices
What situation occurs when everyone loses confidence in a country at the same time?
sudden stop
Which one of the following would be categorized as an unconventional monetary policy tool?
targeted asset purchases
The efficient allocation of resources requires
that prices reflect the relative value of goods and services.
The most important member(s) of the FOMC is (are) considered to be
the Chair of the Board of Governors.
The Federal Reserve and the European Central Bank differ in that only _________________ in its policy framework but are similar in that both use _________ as an operating target.
the ECB emphasizes money; interest rates
Monetary policy is conducted by _______.Fiscal policy is conducted by the _______.
the Fed; Congress
The three branches of the Federal Reserve System include each of the following, except which one?
the Federal Deposit Insurance Corporation.
When the demand for reserves increases,
the Federal Reserve will increase the supply of reserves.
Conducting open market operations is unique to
the New York Branch of the Federal Reserve.
The quantity theory of money implies that a 5% inflation rate can only be caused by
the central bank increasing the money supply by 5%.
Uncontrolled inflation is usually seen as the fault of
the central bank.
Consider a nation that experienced money growth of 2.5%, inflation of 0.5%, and real growth of 4% over some time period. From this information we can calculate
the change in the velocity of money to be 2%.
If the Fed decides to maintain a fixed euro/dollar exchange rate, when they purchase euros
the domestic money supply increases.
Assume that the Fed performs a sterilized foreign exchange intervention in which it buys German government bonds in a world in which reserves are abundant. One result of this will be that
the monetary base does not change.
In dollar amounts,
the monetary base is smaller than M1, and M2 is larger than M1.
The more inflation,
the more systematic risk.
Consider a nation with a money supply of $20 billion, real output of $15 billion; each unit of its currency is spent 3 times a year. Using the equation of exchange we can calculate ______.
the price level to be 4 (20 billion × 3 = the price level × $15 billion)
Ultimately monetary and fiscal policy have
the same ultimate goal but sometimes conflict.
The number of times a dollar is spent over some time period is called __________; when dollars are spent more frequently ____________.
the velocity of money; velocity rises
One reason customers do not care about the quality of their bank's assets is that
there is deposit insurance which protects deposits even if the bank fails.
When banks offer to pay a rate above the primary discount rate,
they are signaling that they don't qualify for primary credit. the are asking for secondary credit.
The European system is designed to give the EBC
tight control over the short-term money market.
Consider the following graph. If the Fed increases the IOER from IOER Rate0 to IOER Rate1, they are implementing what type of policy?
tighter monetary controls where there is an increase in the rate at which banks are willing to lend
Precautionary demand for money refers to a situation where we hold money
to ensure against unexpected expenses.
One reason that the terms of governors on the FOMC run for 14 years is
to overlap presidential terms.
After the financial crisis of 2007 - 2009, the Federal Reserve set the federal funds rate target at essentially zero. This extreme measure was __________ in ending the crisis because _________.
unsuccessful; major financial intermediaries were unwilling to make new loans after so many defaults
The Federal Reserve Bank of New York is unique from other Reserve banks because it is
where the Federal Reserve System's portfolio is managed.
Sterilized exchange rate intervention ________ alter relative asset prices under normal conditions; it changes ______ of the central bank's balance sheet.
will not; the composition