M&B Chapter 11 - Banking Industry: Structure and Competition, CH 11 Banking Industry: Structure and Competition, Chapter 14 Money Supply Process, Practice Problems: M&B, Central Banks and the Federal Reserve System, Chapter 13: Central Banks and the...

Formula for Multiple Deposits

*will use total Reserves formula but will solve for checkable (D) deposits (r*D=R).... -D=(1/r)*R

List two reasons why larger and more complex financial organizations challenge financial regulation

- increased too-big-to-fail problem - extends safety net to new activities, increasing incentives for risk taking in these areas

Feds balance sheet Liabilities

-Currency in Circulation:in hands of public -Reserves: bank deposits at the Fed and vault cash

Feds balance sheet Assets

-Government Securities: holdings by the Fed that affect money supply & earn interest -Discount loans: provide reserves to banks and earn the discount rate

Loans to Financial Institutions

-Monetary liabilities of the Fed have increased by $100 -Monetary base also increases by this amount *BANK SYSTEM* __Assets_________|__Liabilities__ Reserves +100_|_Loans +100 ___________________|__(borrow frm FED) *Federal Reserve system* __Assets__________|__Liabilities__ Securities +100_|__Reserves +100 (Borrow frm Fed)

Feds Ability to control Monetary Base 4

-Open market operations are controlled by the Fed. -The Fed cannot determine the amount of borrowing by banks from the Fed. -Split the monetary base into two components: MBn= MB - BR -The money supply is positively related to both the non-borrowed monetary base MBn and to the level of borrowed reserves, BR, from the Fed.

Open Market Purchase from Nonbank Public

-Person selling the bonds cashes Fed's check -Reserves are unchanged -Currency in circulation increases by the amount of the open market purchase -Monetary base increases by the amount of the open market purchase *Nonbank Public* __Assets_________|__Liabilities__ Securities -100_| Currency +100_| *Federal Reserve System* __Assets__|__Liabilities__ Sec +100_|_Currency in circulation +100

Open Market Sale (MB, BS)

-Reduces the monetary base by the amount of the sale -Reserves remain unchanged -The effect of open market operations on the monetary base is much more certain than the effect on reserves. *Nonbank Public* __Assets_________|__Liabilities__ Securities +100_| Currency -100_| *Federal Reserve System* __Assets__|__Liabilities__ Sec -100_|_Currency in circulation -100

Other Factors that affect the Monetary Base

-Treasury deposits at the Federal Reserve -Interventions in the foreign exchange market

Quantitative Easing

-When the global financial crisis began in the fall of 2007, the Fed initiated lending programs and large-scale asset-purchase programs in an attempt to bolster the economy. -By June 2014, these purchases of securities had led to a quintupling of the Fed's balance sheet and a 377% increase in the monetary base. *This increase in the monetary base did not lead to an equivalent change in the money supply because excess reserves rose dramatically.*

Increase in Currency holdings will do what to MS?

-done by Depositors -decrease the MS because less multiple deposit expansion..less people putting money into the banking system

Increase in excess reserves will do what to MS?

-done by banks -Decrease MS because less loans and deposit creation

Increase in Borrowed reserves(BR)will do what to MS?

-done by banks -Increase MS because more MB for deposit creation

Increase in rr(required reserve ratio)will do what to MS?

-done by the Federal Reserve -Decrease the Money supply because there is less multiple deposit expansion

Increase in MBn(non-borrowed monetary base) will do what to MS?

-done by theFederal reserve system -Increase the Money Supply because there will be more MB for deposit creation

Summary of Open Mrkt Purchase

-effect on *Reserves* depends on whether the seller of the bonds keeps the proceeds from the sale in currency or in deposits -effect on *Monetary Base* will always increase the MB by the amount of the purchase

Three major triggers of financial crisis

1) Asset bubble: rise of asset prices over fundamental economic value 2) Credit boom: starts with lending spree 3) Uncertainty after a major company's default

3 Problems not addressed by dodd frank

1) Compensation in financial industry 2) government sponsored enterprises like fanny may 3) credit rating agencies

Dodd-Frank Act (2010) 5 major provisions

1) Consumer protection 2) Resolution Authority 3) Systematic Risk Regulation 4) Volcker Rule 5) Derivatives

3 Forms of Macroprudential policy

1) Countercyclical capital requirements: requirements adjusted upward during a boom and downward during bust 2) lending credit standards: tighter regulation during booms, more lax during crisis 3) requiring banks to maintain low net stable funding ratio (NSFR)

5 Major effects of great recession

1) boom or bust residential housing prices 2) deterioration of financial institutions balance sheets 3) run on the shadow banking system 4) global financial markets crash 5) failure of high profile firms

3 Major Causes great recession

1) financial innovation in the mortgage markets 2) Agency problems in mortgage markets 3) asymmetric information and credit-rating agencies

3 stages of financial crisis

1) initial phase 2) banking crisis 3) debt deflation

Role of the Chairperson of the Board of Governors

1. Advise the President on economic policy 2. Testifies in Congress 3. Speaks for the Federal Reserve System to the media. 4. May represent the U.S. in negotiations with foreign governments on economic matters.

Role of the Board of Governors

1. Appoint three directors to each FRB 2. Set (within limits) the Reserves Requirements 3. Review and determine the Discount Rate 4. Vote on conduct of Open Market Operations 5. Set Margin requirements 6. Set salaries for President and officers at each FRB and review each bank's budget. 7. Approve bank mergers and applications for new activities 8. Specifies the permissible activities of bank holding companies. 9. Supervise the activities of foreign banks operating in the U.S.

List 4 examples of the impact of information technology on banking

1. Bank credit and debit cards 2. Electronic banking (ATM, home banking, etc.) 3. Junk Bonds 4. Commercial paper market

Role of the FOMC

1. Directs open market operations 2. Advises reserve requirements 3. Advises Discount Rate 4. Meets 8 times a year 5. Issues directives to the trading desk at the Federal Reserve Bank of New York.

Role of the NYC Fed

1. House the Trading Desk 2. Largest and most banks in the district 3. Foreign currency 4. Has gold 5. Close ties to Wall Street 6. Part of the Bank for International Settlements (BIS)

What are the two effects of information technology?

1. Lowered the cost of processing financial transactions 2. Made it easier for investors to acquire information, thereby making it easier for firms to issue securities

Two sets of regulations have seriously restricted the ability of banks to make profits:

1. Reserve requirements that force banks to keep a certain fractions of their deposits as reserves 2. Restrictions on the interest rates that can be paid on the deposits

What are the three basic types of financial innovation?

1. Responses to changes in demand conditions 2. Responses to changes in supply conditions 3. Avoidance of existing regulations

List the 8 basic types of financial regulation aimed at lessening asymmetric information problems and excessive risk taking in the financial system

1. Restrictions on asset holdings 2. Capital requirements 3. Prompt corrective action 4. Chartering and examination 5. Assessment of risk management 6. Disclosure requirements 7. Consumer protection 8. Restrictions on competition

Role of the Federal Reserve Banks

1. Select the Federal Advisory Council 2. Establish the Discount rate 3. Decide which banks can obtain discount loans 4. Clear check and issue new currency 5. Withdraw damaged currency from circulation 6. Administer and make discount loans to banks in their districts 7. Evaluate proposed mergers and applications for banks to expand their activities. 8. Act as liaisons between the business community and Federal Reserve System 9. Examine bank holding companies and state-chartered member banks 10. Collect data on local business conditions 11. Use staffs of professional economists to research topics related to the conduct of monetary policy.

What are the two responses to changes in demand conditions?

1. adjustable-rate mortgages 2. financial derivatives

List the three basic types of financial innovation

1. responses to changes in demand conditions 2. responses to changes in supply conditions 3. avoidance of existing regulations

Three players in Money Supply Process

1.*The Central bank:* Federal Reserve System 2.*Banks*: depository institutions; financial intermediaries 3.*Depositors*: individuals and institutions

Factors that Determine the Money Supply(have Positive relationship)

1.Changes in the nonborrowed Monetary Base (MBn) 2.Changes in borrowed reserves from the Fed (BR)

Factors that Determine the Money Supply(have Negative relationship)

1.Changes in the required reserves ratio(rr) 2.Changes in currency holdings 3.Change in excess reserves

What year was the Bank of North America chartered?

1782

What year was the Federal Reserve System created in?

1913

What year was Glass-Steagall overturned in?

1999

Great Recession Timeline

2002-2006: boom in housing prices 2006: decline in housing prices 2008: credit spread peak 2009: housing prices fall by over 30%

Reserve requirements

3% of the first $48.3 million of checkable deposits, 10% of checkable deposits above that Disadvantages -Can create liquidity problems -Increases uncertainty for banks

To be considered well​ capitalized, a​ bank's leverage ratio must exceed​ ________.

5%

The Basel Accord requires banks to hold as capital an amount that is at least​ ________ of their risk−weighted assets.

8%

A decrease in the discount rate does not normally lead to an increase in borrowed reserves​ because: A.the equilibrium interest rate will still fall below the discount rate. B.there is often a time lag between a decrease in the discount rate and the market reaction to it. C.a decrease in the discount rate usually leads to an increase in nonborrowed reserves. D.setting the discount rate below the equilibrium rate is forbidden by​ law, since a clear arbitrage opportunity would exist.

A

Does inflation targeting help reduce the​ time-inconsistency of discretionary​ policy? A.​Yes, it is a mechanism of​ self-discipline, which effectively ties the hands of policymakers to commit to a policy path. B.​Yes, it decreases the transparency of monetary policy strategy and hence the​ public's expectations of inflation. C.No, inflation targeting decreases the accountability of monetary policymakers. D.​No, there is no direct relationship between inflation targeting and solving the​ time-inconsistency problem.

A

If the Fed has an​ interest-rate target, why will an increase in the demand for reserves lead to a rise in the money​ supply? A.The Fed will conduct open market purchases. B.The Fed will conduct open market sales. C.The Fed will increase reserve requirements. D.The Fed will increase the discount rate.

A

The​ short-run aggregate supply curve slopes upward because an increase in output relative to potential​ output: A.creates tight labor and product markets that cause inflation to rise. B.leads to unstable markets and higher inflation. C.causes markets to have excess​ supplies, putting upward pressure on inflation. D.induces aggregate demand to​ increase, increasing inflation.

A

Why would a central bank be concerned about​ persistent, long-term budget​ deficits? A.It may increase inflation​ expectations, making it harder to keep inflation anchored at a​ low, stable level. B.It always leads to decreases in government​ spending, which lowers output and increases unemployment. C.The government may decide to finance the deficit by issuing​ bonds, which increases its debt and inflation level. D.Policymakers may decide to reduce the deficit by monetizing the​ debt, leading to large decreases in the monetary base.

A

​"If f ​increases, then the Fed can keep output constant by reducing the real interest rate by the same amount as the increase in financial​ frictions." Is this statement​ true, false, or​ uncertain? Explain your answer. A.False. The Fed would need to reduce the real interest rate by a little bit less than the change in f to keep output constant. B.True. The Fed can keep output constant by reducing the real interest rate by the same amount as the increase in financial frictions. C.Uncertain. It depends on whether the​ Fed's distaste for inflation​ (characterized by the parameter lambdaλ​) equals zero or not.

A

​"If prices and wages are perfectly​ flexible, then gammaγ ​= 0 and changes in aggregate demand have a smaller effect on​ output." Is this statement​ true, false, or​ uncertain? Explain your answer. A.False. As prices and wages become more​ flexible, γ becomes​ larger, and thus for a given aggregate demand​ shock, the effects on output are smaller. B.False. When prices and wages are perfectly​ flexible, γ becomes​ smaller, and thus for a given aggregate demand​ shock, the effects on output are always larger. C.True. When γ ​= 0, the​ short-run aggregate supply curve becomes​ steeper, and thus the effects of changes in aggregate demand on output are smaller. D.Uncertain. The effect on output caused by changes in aggregate demand also depends on the size of the output gap.

A

​"The Fed decreased the fed funds rate in late​ 2007, even though inflation was increasing. This demonstrates a violation of the Taylor​ principle." Is this statement​ true, false, or​ uncertain? Explain your answer. A.False. It was the autonomous component of the fed funds rate that was decreased through an autonomous monetary policy easing. The​ Fed's distaste for inflation did not change and remained positive. B.True. Under the Taylor​ principle, the fed funds rate should have been raised by more than any rise in expected inflation. C.Uncertain. Although the responsiveness of the real interest rate to the inflation rate​ declined, which could be a violation of the Taylor​ principle, the real interest rate increased.

A

​"The depreciation of the dollar from December 2008 to December 2009 had a positive effect on aggregate demand in the​ U.S." Is this statement​ true, false, or​ uncertain? Explain your answer. A.True, since a cheaper dollar increases net​ exports, a component of aggregate demand. B.​False, since the​ dollar's value in foreign exchange markets has no bearing upon aggregate demand. C.False, since a dollar depreciation harms U.S. competitiveness in world markets. D.​Uncertain, since many other variables were changing at the same time.

A

​"The federal funds rate can sometimes be below the interest rate paid on​ reserves." Is this statement​ true, false, or​ uncertain? Explain your answer. A.True. This may happen because nonbank financial​ institutions, which cannot earn interest on​ reserves, participate in the federal funds market. B.False. Banks would prefer earning a​ risk-free interest rate rather than loaning excess reserves in the more risky federal funds market at an equivalent or lower rate. C.Uncertain. It depends on the stigma associated for a bank to borrow directly from the Fed.

A

​"When the stock market​ rises, investment is​ increasing." Is this statement​ true, false, or​ uncertain? Explain your answer. A.False. The buying and selling of stocks represents transfers of existing​ assets, and new production does not occur. B.False. When the stock market​ rises, less borrowing is likely to​ occur, thus decreasing investment. C.True. The buying and selling of stocks will increase​ income, so new production must occur. D.Uncertain. Investment spending is most likely influenced by emotional waves of optimism or pessimism and not changes in the stock market.

A

Innovation process leads to the following simple analysis:

A change in the financial environment stimulate a search by financial institutions organizations that are likely to be profitable.

What is a futures contract?

A hedge in which the seller agrees to provide a certain standardized commodity to the buyer on a specific future date at an agreed-on price

What is the Basel Accord?

A provision which 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

35) Factors that provide the Federal Reserve with a high degree of independence include

A) 14-year terms for members of the Board of Governors. B) a four-year term for the chairman of the Board of Governors that is not coincident with the president's term of office. E) only A and B of the above.

3) The unusual structure of the Federal Reserve System is perhaps best explained by

A) Americans' fear of centralized power. B) the traditional American distrust of moneyed interests. E) only A and B of the above.

41) The oldest central bank, founded in 1694, is the

A) Bank of England.

38) Although it enjoys a high degree of autonomy, the Fed is still subject to the influence of Congress because

A) Congress can pass legislation that would restrict the Fed's independence.

42) The newest central bank, which began operations in January 1999, is the

A) European Central Bank.

21) Which of the following are duties of the Board of Governors of the Federal Reserve System?

A) Setting margin requirements, the fraction of the purchase price of securities that has to be paid for with cash.

32) Which of the following are true statements?

A) The FOMC usually meets every six weeks to set monetary policy. B) The FOMC issues directives to the trading desk at the New York Fed. E) Only A and B of the above are true statements.

29) Which of the following are true statements?

A) The FOMC usually meets every six weeks to set monetary policy. B) The FOMC issues directives to the trading desk at the New York Fed. C) Designers of the Federal Reserve Act did not envision the use of open market operations as a monetary policy tool. D) All of the above are true statements.

8) Which of the following is an element of the Federal Reserve System?

A) The Federal Reserve banks B) The Board of Governors E) Only A and B of the above

9) Which of the following is an element of the Federal Reserve System?

A) The Federal Reserve banks B) The Board of Governors C) The FOMC D) All of the above

73) In November 2007, the Fed announced major enhancements to its communication strategy. Which of the following was a part of the changes?

A) The forecast horizon for the FOMC's projections was extended from two calendar years to three. B) The committee publishes FOMC projections four times a year instead of twice a year. C) The release would include a narrative of the forces shaping the outlook and risks to that outlook. D) All of the above were proposed changes.

54) The case for Federal Reserve independence includes the idea that

A) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. B) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced. D) only A and B of the above.

51) The strongest argument for an independent Federal Reserve rests on the view that subjecting the Fed to more political pressures would impart

A) an inflationary bias to monetary policy.

66) The Board of Governors of the Federal Reserve System

A) appoint three directors to each Federal Reserve Bank.

71) The ________ of the Board of Governors is the spokesperson for the Fed

A) chairman

20) The Fed's support of the Depository Institutions Deregulation and Monetary Control Act of 1980 stemmed in part from its

A) concern over declining Fed membership.

26) The Board of Governors

A) establishes, within limits, reserve requirements. B) effectively sets the discount rate. C) sets margin requirements. D) does all of the above.

44) A trend in recent years is that more and more governments

A) have been granting greater independence to their central banks.

58) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control would

A) impart an inflationary bias to monetary policy. B) force monetary authorities to sacrifice the long-run objective of price stability. E) do only A and B of the above.

57) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control would

A) impart an inflationary bias to monetary policy. B) force monetary authorities to sacrifice the long-run objective of price stability. C) make the so-called political business cycle even more pronounced. D) do all of the above.

52) Politicians in a democratic society may be shortsighted because of their desire to win reelection; thus, the political process can

A) impart an inflationary bias to monetary policy. C) generate a political business cycle in which, just before an election, expansionary policies are pursued to lower unemployment and interest rates. D) cause both A and C of the above to occur.

67) The Federal Advisory Council has ________ member(s) from each district.

A) one

63) Instrument independence means the central bank is free from

A) political pressure regarding how it uses the tools of monetary policy.

53) The case for Federal Reserve independence includes the idea that

A) political pressure would impart an inflationary bias to monetary policy. B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. C) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced. D) all of the above.

39) According to the textbook authors, the Fed is

A) remarkably free of the political pressures that influence other government agencies. C) probably somewhat constrained in its policymaking by the congressional threat to reduce Fed independence. D) both A and C of the above.

49) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed

A) resists so vigorously congressional attempts to limit the central bank's autonomy. B) is secretive about the conduct of future monetary policy. E) only A and B of the above.

33) The designers of the Federal Reserve Act meant to create a central bank characterized by its

A) system of checks and balances and decentralization of power.

61) Critics of Fed independence argue

A) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one.

62) Critics of Fed independence argue

A) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one. B) that independence seemingly does little to guarantee good monetary policy. C) that its independence may encourage the Fed to pursue a course of narrow self-interest rather than the public interest. D) all of the above.

40) According to the textbook authors,

A) the Fed appears to be remarkably free of the political pressures that influence other government agencies. B) since the president can protect the Fed from Congress, the Fed may be responsive to the president's policy preferences. D) both A and B of the above.

34) The power within the Federal Reserve was effectively transferred to the Board of Governors by

A) the banking legislation of the Great Depression.

60) Critics of the current system of Fed independence contend that

A) the current system is undemocratic.

4) The traditional American distrust of moneyed interests and the fear of centralized power help to explain

A) the failures of the first two experiments in central banking in the United States. B) the decentralized structure of the Federal Reserve System. C) why the Board of Governors of the Federal Reserve System is not located in New York. D) all of the above.

48) According to the theory of bureaucratic behavior,

A) the objective of a bureaucracy is to maximize its own welfare, meaning that it seeks additional power and prestige. B) the bureaucracy will fight vigorously to preserve its autonomy; thus, it will attempt to avoid conflict with the president and Congress. C) the bureaucracy will support legislation that gives it additional regulatory power. D) all of the above describe bureaucratic behavior.

70) The 12 Federal Reserve banks are involved in monetary policy in several ways:

A) their directors establish the discount rate. B) they decide which banks can obtain discount loans from the Federal Reserve Bank. C) their directors select one commercial banker from each bank's district to serve on the Federal Advisory Council. D) all of the above.

23) The chairman of the Board of Governors of the Federal Reserve System exercises a high degree of control over the board

A) through his ability to set the agenda of the Board and the FOMC. B) through his role as spokesperson for the Fed with the President and before Congress. E) because of only A and B of the above.

47) According to the theory of bureaucratic behavior, the objective of bureaucracy is

A) to maximize its own welfare, meaning that it seeks additional power and prestige.

46) The theory of bureaucratic behavior suggests that the Federal Reserve will

A) try to avoid a conflict with the president and Congress over increases in interest rates. B) try to gain regulatory power over more banks. C) devise clever strategies in an effort to avoid blame for poor economic performance. D) do all of the above.

Under the Basel​ Accord, assets and off−balance sheet activities were sorted according to​ ________ categories with each category assigned a different weight to reflect the amount of​ ________. A. ​4; credit risk B. ​2; credit risk C. ​2; adverse selection D. ​4; adverse selection

A. 4; credit risk

The government safety net creates​ ________ problem because risk−loving entrepreneurs might find banking an attractive industry. A. an adverse selection B. a lemons C. a revenue D. a moral hazard

A. an adverse selection

Adjustable rate mortgages... A. benefit homeowners when interest rates are falling. B. protect households against higher mortgage payments when interest rates rise. C. keep financial​ institutions' earnings high even when interest rates are falling. D. generally have higher initial interest rates than on conventional fixed−rate mortgages.

A. benefit homeowners when interest rates are falling.

New computer technology has... A. reduced the cost of financial innovation. B. increased the demand for financial innovation. C. reduced the demand for financial innovation. D. increased the cost of financial innovation.

A. reduced the cost of financial innovation.

​________ is creating a marketable capital market instrument by bundling a portfolio of mortgage or auto loans. A. securitization. B. arbitrage. C. computerization. D. diversification.

A. securitization.

The primary difference between the​ "payoff" and the​ "purchase and​ assumption" methods of handling failed banks is... A. that the FDIC guarantees all deposits when it uses the​ "purchase and​ assumption" method. B. that the FDIC is more likely to use the​ "payoff" method when the bank is large and it fears that depositor losses may spur business bankruptcies and other bank failures. C. that the FDIC guarantees all deposits when it uses the​ "payoff" method. D. that the FDIC is more likely to use the purchase and assumption method for small institutions because it will be easier to find a purchaser for them compared to large institutions.

A. that the FDIC guarantees all deposits when it uses the​ "purchase and​ assumption" method.

What is a sweep account?

An innovation that enables banks to avoid the tax from reserve requirements: any balances above a certain amount in a corporation's checking account at the end of a business day are "swept out" of the account and invested in overnight securities that pay interest

Member Banks

Around 2,500 member commercial banks and they elect six directors to each FRB.

Explain how securitization is involved in the shadow banking system.

Asset transformation is accomplished through securitization and the shadow banking system is not done "under one roof" as is traditional banking

__________ ____________ is a rationale for financial regulation.

Asymmetric information

Troubled Asset Relief Program (TARP)

Authorized treasury to spend $700 billion repurchasing subprime mortgage assets under the EESA

Combines in one location an ATM, an Internet connection to the bank's website, and a telephone link to customer service.

Automated Banking Machine (ABM)

And electronic machine that allows customers to get cash, make deposits, transfer funds from one account to another, and check balances.

Automated Teller Machine (ATM)

"Interest rates can be measured more accurately and quickly than reserve​ aggregates; hence an interest rate is preferred to the reserve aggregates as a policy​ instrument." Do you agree or​ disagree? A.Agree. Policymakers care only about nominal interest rates when making policy decisions and do not use the money supply or its aggregates in making decisions. B.Disagree. The measurement of real interest rates requires estimates of expected​ inflation, and it is not true that real interest rates are necessarily measured more accurately and quickly than the money supply. C.Disagree. Nominal interest rates are measured more accurately and quickly than the money​ supply; therefore,​ interest-rate targets are not necessarily better than​ money-supply targets. D.Agree. Although nominal interest rates are measured more accurately and quickly than the money​ supply, the​ interest-rate variable that is of more concern to policymakers is the real interest rate.

B

Following the global financial crisis in​ 2008, assets on the Federal​ Reserve's balance sheet increased​ dramatically, from approximately​ $800 billion at the end of 2007 to​ $3 trillion in 2011. Many of the assets held are​ longer-term securities acquired through various loan programs instituted as a result of the crisis. In this​ situation, how could reverse repos​ (matched sale-purchase​ transactions) help the Fed reduce its assets held in an orderly​ fashion, while reducing potential inflationary problems in the​ future? A.Reverse repos serve as a temporary open market sale in which the Federal Reserve temporarily sells assets to further increase its balance​ sheet, thus increasing the money supply and lowering​ short-term interest rates. B.Reverse repos serve as a temporary open market sale in which the Federal Reserve temporarily sells assets to reduce its balance​ sheet, thus decreasing the money supply and raising​ short-term interest rates. C.Reverse repos serve as dynamic open market operations that are intended to permanently reduce the Federal​ Reserve's balance​ sheet, thus limiting fluctuations in the money supply. D.In this​ situation, the Fed should engage in repurchase agreements​ (a repo) rather than reverse​ repos, as this would further expand reserves and the monetary base.

B

If households and firms believe the economy will be in a recession in the​ future, will this necessarily cause a​ recession, or have any impact on output at​ all? A.While such pessimistic expectations can reduce autonomous​ investment, these beliefs cannot affect equilibrium output to the point where a recession is likely. B.If these beliefs are strong​ enough, it could reduce autonomous investment to a point where equilibrium output decreases​ significantly, leading to a recession. C.Such emotional​ beliefs, or animal​ spirits, are based on rational expectations and therefore are an accurate predictor of the economy. D.These expectations may create uncertainty in an​ economy; however, they are irrational and will have no impact on output at all.

B

Would it be problematic for a central bank to have a primary goal of maximizing economic​ growth? A.Yes, because this may result in structural changes in the economy that could lead to an increase in inflation. B.Yes comma because this could lead to imbalances in the economy that could lead to bubbles and financial crises.Yes, because this could lead to imbalances in the economy that could lead to bubbles and financial crises. nothing C.​No, by maximizing economic​ growth, a central bank can effectively achieve its goal of high employment and price stability. D.No, because this could balance the economy and prevent bubbles and financial crises from occurring.

B

​"If the demand for reserves did not​ fluctuate, the Fed could pursue both a reserves target and an​ interest-rate target at the same​ time." Is this statement​ true, false, or​ uncertain? Explain your answer. A.False. A reserves target and​ interest-rate target can never have the same policy outcome. B.True. The target interest rate would have a set level of reserves that would only change if the Fed desired. C. True. The nominal interest rate and the real interest rate would have to be the same. D.Uncertain. There is not enough information about how the interest rate would be set.

B

​"Since inventories can be costly to​ hold, firms' planned inventory investment should be​ zero, and firms should acquire inventory only through unplanned inventory​ accumulation." Is this statement​ true, false, or​ uncertain? Explain your answer. A.True. Firms will earn more by purchasing securities and thus should not hold excess inventory. B.False. Firms may prefer to hold excess inventory to meet unpredictable consumer demands. C.False. If the cost of real borrowing is​ low, firms should increase their inventory holdings to increase future profits. D.Uncertain. The mpc is required to determine whether holding the additional inventory is worth the cost.

B

72) Currently, there are ________ countries that are members of the European Monetary Union.

B) 12

43) Which of the following central banks has the greatest degree of independence?

B) European Central Bank

31) The Federal Reserve entity that determines monetary policy strategy is the

B) Federal Open Market Committee.

12) Which Federal Reserve Bank president always has a vote in the Federal Open Market Committee?

B) New York

22) Which of the following are not duties of the Board of Governors of the Federal Reserve System?

B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q.

10) Which of the following is not an entity of the Federal Reserve System?

B) The FDIC

7) The many regional Federal Reserve banks resulted from a compromise between parties favoring

B) a private central bank and those favoring a government institution.

64) Suppose legislation requiring the Fed to keep the inflation rate between 1.5% and 2.5% per year is passed by Congress. This law restricts the Fed's

B) goal independence.

50) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed

B) is secretive about the conduct of future monetary policy.

45) The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximize

B) its own welfare.

65) Cross-country evidence suggests that an increase in central bank independence results in a ________ inflation rate and ________ unemployment.

B) lower; no worse

16) All ________ are required to be members of the Fed.

B) nationally chartered banks

69) The directors of a district bank are classified into three categories: A, B, and C. The three B directors are

B) prominent leaders from industry, labor, agriculture, or the consumer sector.

59) Supporters of the current system of Fed independence believe that a less autonomous Fed would

B) pursue overly expansionary monetary policies. C) be more likely to create a political business cycle. D) do only B and C of the above.

6) Nationwide financial panics in 1873, 1884, 1893, and 1907 might have been avoided had

B) the Second Bank of the United States not been abolished in 1836 by President Andrew Jackson.

56) The case for Federal Reserve independence does not include the idea that

B) the principal-agent problem is perhaps worse for the Fed than for congressmen since the former does not answer to the voters on election day.

A bank failure is less likely to occur when... A. a bank holds less U.S. government securities. B. a bank has more bank capital. C. a bank holds fewer excess reserves. D. a bank suffers large deposit outflows.

B. a bank has more bank capital.

Companies that own one or more banks.

Bank Holding Companies

What has been the cause of the decline in the number of banks?

Bank consolidation - banks have been merging to create larger entities or have been buying up other banks.

The rapid development in information technology have resulted in many new financial products and services such as? (responses to changes in supply conditions)

Bank credit and debit cards, electronic banking, junk bonds, commercial paper market, and securitization

Depositors lack of information about the quality of bank assets can lead to​ ________.

Bank panics

What does a dual banking system mean?

Banks chartered by the federal government and banks chartered by the states operate side by side.

Shifts in Supply and Demand and the Limits of iff changes

Basically, iff has an upper bound (id) and a lower bound (ier)

Describe how​ (if at​ all) the IS​ curve, MP​ curve, and AD curve are affected in the following ​situation: The new Federal Reserve chair begins to care more about fighting inflation.The new Federal Reserve chair begins to care more about fighting inflation. A.The IS and AD curves shift to the left, and the MP curve does not shift.The IS and AD curves shift to the left, and the MP curve does not shift. nbsp B.None of the curves are affected.None of the curves are affected. C.The IS curve is not affected, the MP curve becomes steeper, and the slope of the AD curve becomes flatter.The IS curve is not affected, the MP curve becomes steeper, and the slope of the AD curve becomes flatter. D.The economy moves along the IS curve, the MP curve shifts down, and the net effect on the AD curve cannot beThe economy moves along the IS curve, the MP curve shifts down, and the net effect on the AD curve cannot be definitely determined. E.The AD curve shifts to the left, the MP curve becomes flatter, and the slope of the IS curve becomes steeper.

C

During an expansin​, how would you expect velocity to typically behave over the business​ cycle? A.Velocity will not change because real GDP will rise and restrictive policy will be implemented.not change because real GDP will rise and restrictive policy will be implemented. B. Velocity will decline comma since it will become less convenient for purchases to be paid for with cash or checks.decline, since it will become less convenient for purchases to be paid for with cash or checks. C.Velocity will increase comma since the money supply will be less expansionary comma and nominal GDP will rise.increase, since the money supply will be less expansionary, and nominal GDP will rise. D.The change in velocity will be unpredictable because of high inflation and price fluctuations.

C

How is an autonomous tightening or easing of monetary policy different than a change in the real interest rate due to a change in the current inflation​ rate? A.Tightening or easing of monetary policy may cause a change in the responsiveness of the real interest rate to the inflation​ rate, not in its autonomous component. B.Tightening or easing of monetary policy is reflected as a movement along the monetary curve rather than an upward or downward shift of the curve. C.With a tightening or easing of monetary​ policy, some projected changes in monetary policy independent of the current inflation rate may occur. D.Autonomous tightening or easing of monetary policy is based on a change in the nominal interest​ rate, not the real interest rate.

C

What is the advantage of quantitative easing as an alternative to conventional monetary policy when​ short-term interest rates are at the zero​ lower-bound? A.Quantitative easing always causes an increase in economic activity through greater loans and monetary expansion.Quantitative easing always causes an increase in economic activity through greater loans and monetary expansion. B.Banks hold the extra liquidity received from quantitative easing as excess reserves and hence decrease their risks.Banks hold the extra liquidity received from quantitative easing as excess reserves and hence decrease their risks. C.Purchases of longer minus term securities could reduce longer minus term interest rates and hence lead to an expansion.Purchases of longer−term securities could reduce longer−term interest rates and hence lead to an expansion. D.Purchases of intermediate securities could further decrease the money supply and hence lead to an increase inPurchases of intermediate securities could further decrease the money supply and hence lead to an increase in borrowing.

C

What is the key assumption underlying the​ Fed's ability to control the real interest​ rate? A.It is the real interest​ rate, not the nominal​ rate, that determines the level of equilibrium output. B.The real interest rate is the nominal interest rate minus expected inflation. C.Because inflation is relatively sticky in the short​ run, when the Federal Reserve changes the federal funds​ rate, it implies similar changes in real interest rates. D.Nominal interest rates should be increased by more than any rise in expected inflation to stabilize inflation.

C

​"A central bank with a dual mandate will achieve lower unemployment in the long run than a central bank with a hierarchical mandate in which price stability takes​ precedence." Is this statement true or​ false? Explain your answer. A.True. The​ short-run Phillips curve shows an inverse relationship between inflation and unemployment. B.True. Inflation targeting only allows a central bank to focus on inflation. C.False. There is no​ long-run trade-off between inflation and unemployment. D.False. Inflation targeting still allows central banks to constantly adjust for unemployment concerns.

C

​"If nominal GDP​ rises, velocity always​ rises." Is this statement​ true, false, or​ uncertain? A.True. If nominal GDP​ rises, the money supply decreases and hence velocity will always rise. B.False. If nominal GDP​ rises, the money supply will rise proportionately and hence velocity will remain constant. C.False. If the money supply increases by a greater amount than nominal​ GDP, velocity will decline. D.Uncertain. It depends on whether nominal GDP increases because of an increase in P or an increase in Y.

C

25) Each member of the seven-member Board of Governors is appointed by the president and confirmed by the Senate to serve

C) 14-year terms.

18) Of all commercial banks, about ________ percent belong to the Federal Reserve System.

C) 30

11) Which of the following functions are not performed by any of the twelve regional Federal Reserve banks?

C) Setting interest rates payable on time deposits

2) Bank panics in 1819, 1837, 1857, 1873, 1884, 1893, and 1907 convinced many that

C) a central bank was needed to prevent future financial panics.

24) Members of the Board of Governors are

C) appointed by the president of the United States and confirmed by the Senate as members resign.

36) Federal Reserve independence is thought to

C) introduce longer-run considerations to monetary policymaking.

55) The case for Federal Reserve independence does not include the idea that

C) policy is always performed better by an elite group such as the Fed.

37) Members of Congress are able to influence monetary policy, albeit indirectly, through their ability to

C) propose legislation that would force the Fed to submit budget requests to Congress, as must other government agencies.

27) Although neither ________ nor the ________ is officially set by the Federal Open Market Committee, decisions concerning these policy tools are effectively made by the committee.

C) reserve requirements; discount rate

28) Although the Federal Open Market Committee does not have formal authority to set ________ and the ________, it does possess the authority in practice.

C) reserve requirements; discount rate

5) Member commercial banks have purchased stock in their district Fed banks; the dividend paid by that stock is limited to

C) six percent annually.

30) The Federal Open Market Committee consists of

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

An instrument developed to help investors and institutions hedge interest−rate risk is... A. a credit card. B. a junk bond. C. a financial derivative. D. a debit card.

C. a financial derivative.

When bad drivers line up to purchase collision​ insurance, automobile insurers are subject to the... A. moral hazard problem. B. ill queue problem. C. adverse selection problem. D. assigned risk problem

C. adverse selection problem.

Since​ depositors, like any​ lender, only receive fixed payments while the bank keeps any surplus​ profits, they face the​ ________ problem that banks may take on too​ ________ risk. A. adverse​ selection; little B. moral​ hazard; little C. moral​ hazard; much D. adverse​ selection; much

C. moral​ hazard; much

If the FDIC decides that a bank is too big to​ fail, it will use the​ ________ method, effectively ensuring that​ ________ depositors will suffer losses. A. ​payoff; large B. purchase and​ assumption; large C. purchase and​ assumption; no D. ​payoff; no

C. purchase and​ assumption; no

Banks have attempted to maintain adequate profit levels by... A. increasing reserve deposits at the Fed. B. decreasing capital accounts.. C. pursuing new off−balance−sheet activities. D. making fewer riskier​ loans, such as commercial real estate loans.

C. pursuing new off−balance−sheet activities.

The most significant change in the economic environment that changed the demand for financial products in recent years has been... A. the aging of the baby−boomer generation. B. the deregulation of financial institutions. C. the dramatic increase in the volatility of interest rates. D. the dramatic increase in competition from foreign banks.

C. the dramatic increase in the volatility of interest rates.

A problem with the too−big−to−fail policy is that it​ ________ the incentives for​ ________ by big banks. A. ​decreases; moral hazard B. ​decreases; adverse selection C. ​increases; moral hazard D. ​increases; adverse selection

C. ​increases; moral hazard

What effect has financial innovation had on traditional banking?

Causing a decline -- market share has fallen, commercial banks' share of total financial intermediary assets has fallen -- no decline in overall profitability, increase in income from off-balance-sheet activities

A government institution that has responsibility for the amount of money and credit supplied in the economy as a whole.

Central Bank

The government institution that has responsibility for the amount of money and credit supplied in the economy as a whole is the...

Central bank

Because of asymmetric​ information, the failure of one bank can lead to runs on other banks. This is the...

Contagion effect

What did the National Bank Act of 1863 do?

Created a new banking system of federally chartered banks; the Office of the Comptroller of the Currency and a dual banking system

According to​ Keynes's analysis of the speculative demand for​ money, which of the following shows that velocity will undergo substantial fluctuations and thus cannot be treated as​ constant? A.Keynes believed that changes in​ people's expectations about what the normal level of interest rates are will cause money demand and hence velocity to fluctuate. B.Since Keynes believed velocity is affected by interest rates and interest rates fluctuate a​ lot, velocity will as well. C.Keynes believed that money demand and hence velocity are affected by interest rates. D.All of the above are correct. E.None of the above are correct.

D

In​ Keynes's analysis of the speculative demand for​ money, what will happen to money demand if people suddenly decide that the normal level of the interest rate has​ declined? Why? A.Money demand will increase because people will want to borrow more money. B.Money demand will stay the same because the speculative component of the demand for money is viewed as insensitive to interest rates. C.Money demand will increase because as interest rates​ fall, the price of bonds falls. The relative decrease in the expected return on bonds makes money more attractive. D.Money demand will decrease because as interest rates​ fall, the price of bonds rises. The relative increase in the expected return on bonds makes money less attractive.

D

When comparing the monetary base to M1 on the grounds of controllability and​ measurability, why would you prefer the monetary base as an intermediate​ target? A.The monetary base is measured more accurately and quickly. B.The monetary base is more directly influenced by the tools of the Fed. C.The Fed can calculate data on the monetary base from its own balance sheet​ data, while it constructs M1 numbers from surveys of​ banks, which take some time to collect and are not always that accurate. D.All of the above are correct.

D

Why is paying interest on reserves an important tool for the Federal Reserve to manage​ crises? A.It allows for fluctuations in the federal funds​ rate, making monetary policy more flexible. B.It allows the Fed to increase the money supply to support excessive demand for goods and services. C.It allows the Fed to increase the effective tax on​ deposits, thereby increasing economic efficiency. D.It allows the Fed to increase its lending as much as it wants without reducing the federal funds rate.

D

Why is the composition of the​ Fed's balance sheet a potentially important aspect of monetary policy during a​ crisis? A.A consistent composition of the​ Fed's balance sheet provides transparency and certainty for markets and households in making decisions about the future. B.Providing liquidity to financial organizations adds reserves to the general banking system and reduces risk. C.When the Fed provides liquidity to a particular segment of the credit​ market, it can freeze the market and hence decrease inflation. D.The Fed can influence interest rates and provide more targeted liquidity.

D

You often read in the newspaper that the Fed has just lowered the discount rate. Does this signal that the Fed is moving to a more expansionary monetary​ policy? Why or why​ not? A.Yes. The Fed usually uses the discount rate to manipulate the money supply. B.No. The Fed usually lowers the discount rate to signal contractionary policy. C.Yes. The Fed usually uses the discount rate to signal the future of monetary policy. D.No. The Fed usually lowers the discount rate when market rates fall regardless of the direction of monetary policy.

D

​"Since financial crises can impart severe damage to the​ economy, a central​ bank's primary goal should be to ensure stability in financial​ markets." Is this statement​ true, false, or​ uncertain? Explain your answer. A.True. If financial market stability is​ maintained, then funds are channeled to the most productive investment​ opportunities, thus leading to an expansion in economic activity. B.False. Price stability should always be the primary goal of any central bank. C.True. If financial market stability had been​ pursued, the​ 2007-2009 recession would have been prevented. D.Uncertain. Although stability in financial markets is an important​ goal, focusing on other goals such as stabilizing​ employment, output, or even​ short-term movements in the business cycle may be more important to the economy.

D

14) The ________ Fed bank, with about 25 percent of the system's assets, is the most important of the Federal Reserve banks.

D) New York

68) The three largest Federal Reserve banks in terms of assets are those of New York, Chicago, and

D) San Francisco.

5) The financial panic of 1907 resulted in such widespread bank failures and substantial losses to depositors that the American public finally became convinced that

D) a central bank was needed to prevent future panics.

13) Each Fed bank president attends FOMC meetings; although only ________ Fed bank presidents vote on policy, all ________ provide input.

D) five; twelve

17) Which of the following banks are required to be members of the Federal Reserve System?

D) none of the above

1) Americans' fear of centralized power and their distrust of moneyed interests explain why the U.S. did not have a central bank until the

D)20th century

The leverage ratio is the ratio of a​ bank's... A. capital divided by its total liabilities. B. income divided by its assets. C. assets divided by its liabilities. D. capital divided by its total assets.

D. capital divided by its total assets.

The Basel​ Accord, an international​ agreement, requires banks to hold capital based on... A. deposits. B. liabilities. C. the total value of assets. D. risk−weighted assets.

D. risk−weighted assets.

Although the FDIC was created to prevent bank​ failures, its existence encourages banks to... A. hold too much capital. B. buy too much stock. C. open too many branches. D. take too much risk.

D. take too much risk.

The most important developments that reduced​ banks' income advantages​ include: A. the elimination of Regulation Q ceilings. B. the increase in off−balance sheet activities. C. the competition from money market mutual funds. D. the growth of securitization.

D. the growth of securitization.

The result of the too−big−to−fail policy is that​ ________ banks will take on​ ________ risks, making bank failures more likely. A. ​small; greater B. small; fewer C. ​big; fewer D. ​big; greater

D. ​big; greater

If higher inflation is​ bad, then why might it be advantageous to have a higher inflation​ target, rather than a lower target closer to​ zero? A.A higher inflation target leads to increased communication with the public and thus reduces uncertainty. B.It is easier to stabilize the economy with a higher inflation target than a target closer to zero. C.Central banks are more accountable with a higher inflation​ target, thus solving the​ time-inconsistency problem. D.A higher inflation target is less binding than a target closer to zero.

D`

The number of banks has ___________ dramatically over the last 30 years.

Declined

Bank panics caused a need for what?

Deposit insurance

What effect does a bank failure have on depositors?

Depositors would have to wait until the bank was liquidated (assets turned into cash) to get their deposit funds; at that time, they would only be paid a fraction of the value of their deposits.

Discount Policy and the Lender of Last resort

Discount rate isn't great for controlling money supply, but lender of last resort role is Primary credit: short term loans to healthy banks to meet reserve requirements Secondary credit: longer term loans to troubled banks with severe liquidity problems Seasonal credit: loans to small banks that have seasonal cash flow (agricultural and vacation areas) Fed charges slightly higher interest rate on second two Lender of last resort to prevent financial panics- creates moral hazard problems (safety net for banks, causes them to take risks) Advantages and Disadvantages of discount policy -It is used to perform the lender of last resort role (important during the subprime crisis of 2008-9) -But the amount of discount loans cannot be controlled by the fed; the decision maker is the individual bank (has to take the loan)

Loss of deposits from the banking system restricted the amount of funds that banks could lend.

Disintermediation

People begin to take their money out of banks, with their low interest rates on both checkable and time deposits, and began to seek out higher-yielding investments.

Disintermediation

Banks supervised by the federal government and banks supervised by the state operate side-by-side.

Dual Banking System

Conventional monetary policy tools

During normal times, three tools to control the money supply and interest rates: (1) OMO (2) Discount lending (3) reserve requirements

Open Market Operations (dominant tool)

Dynamic open market operations -Intended to change the monetary base, typically in conjunction with a change in the target (intended) federal funds rate -these are done after FOMC meetings and are meant to change the iff Defensive open market operations -Intended to offset changes in other factors that affect the monetary base, typically conducted to maintain the fed funds rate at its target level -these are the things that happen everyday to maintain iff at current level Advantages of OMO -Fed has complete control over the volume -Flexible and precise -Easily reverse -Quickly implemented

What methods have​ inflation-targeting central banks used to increase communication with the public and increase the transparency of monetary policy​ making? A.​Inflation-targeting central banks have used brochures with fancy​ graphics, boxes, and other​ eye-catching design elements to engage the​ public's interest. B.Inflation-targeting central banks have frequent communications with the government. C.​Inflation-targeting central banks take the opportunity to make public speeches on their monetary policy strategy. D.Only B and C are correct. E.All of the above are correct.

E

19) Banks subject to reserve requirements set by the Federal Reserve System include

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

Twelve Federal Reserve Banks (FRBs)

Each has nine directors who appoint the president and other officers of the FRB. Quasi-Public institutions owned by private commercial banks in the district that are members of the Fed System. Financially independent from the government.

What did the Riegle-Neal Interstate Banking and Branching Efficiency Act do?

Expanded the regional compacts to the entire nation and allowed bank holding companies to acquire banks in any other state, notwithstanding any state laws to the contrary, but bank holding companies could also merge the banks they owned into one bank with branches in different states

11) Critics of the current system of Fed independence contend that the president has too much control over monetary policy on a day-to-day basis.

FALSE

12) Countries with more independent central banks have lower inflation rates, but these have come at the expense of greater output fluctuations.

FALSE

14) The Fed has goal independence but not instrument independence.

FALSE

2) Rapid money supply growth and uncontrollable inflation were among the factors which motivated the creation of the Federal Reserve System.

FALSE

3) The Washington, D.C. Fed bank, with over 30 percent of the system's assets, is the most important Federal Reserve Bank.

FALSE

8) Monetary policy is set by the Board of Governors.

FALSE

9) Federal Reserve monetary policy decisions must be approved by the Secretary of the Treasury before they may be implemented.

FALSE

To prevent bank runs and the consequent bank​ failures, the United States established the​ ________ in 1934 to provide deposit insurance.

FDIC

DFA Resolution Authority

FDIC can seize failing financial institutions (not just banks) they deem bad

Provide federal insurance on bank deposits. Established in 1933 to prevent future depositor losses from failures such as the Great Depression.

Federal Deposit Insurance Corporation (FDIC)

Federal Reserve System

Federal Reserve Banks, Board of Governors of the Federal Reserve System, the Federal Open Market Committee (FOMC), the Federal Advisory council, and around 2,000 member commercial banks.

Futures contracts and financial instruments which are called _____________ ________________ because their payoffs are linked to previously issued securities, they could be used to hedge risk.

Financial Derivatives -Born in 1975

To survive in the new economic environment, financial institutions have to research and develop new products and services that will meet customer needs and prove profitable.

Financial Engineering

DFA Systematic risk regulation

Financial Stability Oversight Council SIFIs must create "living will" for liquidation in case of trouble

​________ is the process of researching and developing profitable new products and services by financial institutions.

Financial engineering

Government regulation leads to what?

Financial innovation by creating incentives for firms to skirt regulations that restrict their ability to earn profits.

Macroprudential supervision

Focus on the financial system in aggregate Mitigates risks linked to financial sector concentration and interconnectedness

The seller agrees to provide a certain standardized commodity to the buyer on a specific future date at an agreed-on price

Futures Contracts

What are financial derivatives?

Futures contracts in financial instruments

Banking legislation in 1933 that prohibited commercial banks from underwriting or detailing in corporate securities and limited banks to the purchase of debt securities approved by the bank regulatory agencies. It also prohibited the investment banks from engaging in commercial banking activities. Repealed in 1999.

Glass-Steagall Act

The​ ________ that required separation of commercial and investment banking was repealed in 1999.

Glass-Steagall Act

What did the Federalists advocate for?

Greater centralized control of banking and federal chartering of banks -their efforts lead to the creation and 1791 of the Bank of United States, which had elements of both a private bank and a central bank.

Protection from interest-rate risk.

Hedge

What happened with the elimination of regulation Q?

Help make banks more competitive in their quest for funds, it also meant that their cost of acquiring funds has risen substantially, thereby reducing their earlier cost advantage over other financial institutions.

Open market purchase from a Bank

Increases the Federal reserve by amount of purchase. -No change in currency -Monetary base will also rise by amount of purchase *BANK SYSTEM* __Assets_________|__Liabilities__ Securities -100_| Reserves +100_| *Federal Reserve system* __Assets_________|__Liabilities__ Securities +100_|__Reserves +100

Increase in the Interest rate paid on loans at the fed (ier)

Increases the horizontal portion of demand curve

Advances in _______________ have been critical to the growth of securitization and the shadow banking system.

Information Technology

Independence of the Fed

Instrument (ability to set monetary policy instruments) and goal independence (ability to set the goals of monetary policy); Independent revenue; Fed's structure written by Congress and subject to change at anytime; Presidential influence: influence on congress, appoints members, appoints chairman although terms are not concurrent.

What is the main concern of nationwide banking?

It will eliminate community banks, thus resulting in less lending to small businesses and also making the banking business less competitive.

Unconventional tools during the global financial crisis

Liquidity provision: fed implemented unprecedented increases in its lending facilities to provide liquidity to financial markets

Money supply formula

M=m*MB m=money multiplier M=money supply

Monetary Base formula (MB)

MB= C + R C=currency in circulation R=total reserves in banking system

What makes adjustable-rate mortgages attractive to households?

Many mortgage-issuing institutions will issue adjustable-rate mortgages with lower initial interest rates than those on conventional fixed-rate mortgages.

Not legally deposits and so are not subject to reserve requirements for prohibitions on Interest payments. For this reason, they can pay higher interest rates than deposits at banks

Money Market Mutual Funds

When one party to a transaction has incentives to engage in activities detrimental to the other​ party, there exists a problem of...

Moral hazard

To eliminate the abuses of the state-chartered banks, the National Bank Act of 1863 created a new banking system of federally chartered banks called _________________.

National Banks

What is the mother of innovation?

Necessity

The simultaneous decline of cost and income advantages has resulted in what?

Reduce profitability of traditional banking and an effort by banks to leave this business and engage in new and more profitable activities.

The process of transforming otherwise illiquid financial assets, which have typically been the bread and butter of banking institutions, into marketable capital market securities.

Securitization

_______________ is the fundamental building block of the shadow banking system.

Securitization

Federal Open Market Committee (FOMC)

Seven members of Board of Governors plus the President of the New York FRB and presidents from four other FRBs.

Board of Governors

Seven members, including the chairman, appointed by the President of the US and confirmed by the Senate. 14-year nonrenewable term (political independence). Required to come from different districts. Chairperson is chosen from the governors and serves four-year term.

Bank lending has been replaced by lending the securities markets.

Shadow Banking System

Increases in the discount rate

Shifts flat portion of supply curve up

Increase in reserve requirement

Shifts the diagonal portion of the demand curve to the right

Open Market Purchase of Securities

Shifts vertical portion of the supply curve to the right

Demand in the Market for Reserves

Since the fall of 2008, the Fed has paid interest on reserves at a level that is set at a fixed amount below the fed funds rate target When the fed funds rate is above the interest rate paid on excess reserves, ier, as the federal funds rate decreases, the opportunity cost of holding excess reserves falls, and the quantity demanded of reserved increases Downward sloping demand curve becomes flat at ier (when fed funds rate lowers below ier, a bank has no reason to loan more to banks, instead puts all of reserves in fed)

What are credit unions?

Small cooperative lending institutions organized around a particular group of individuals with a common bond - the only depository institutions that are tax-exempt and can be chartered either by the states or by the federal government

Great Depression timeline

So severe because prices fell by 25% creating a huge debt deflation problem 1929: stock market crash 1930: severe midwest drought 1930: bank panic 1932: decline in stock prices Debt Deflation

State-chartered banks

State Banks

Who has sole jurisdiction over state banks without FDIC insurance?

State banking authorities

Enables banks to avoid the "tax" from reserve requirements. In this arrangement, any balances above a certain amount in a corporation's checking account at the end of business day are "swept out" the account and invested overnight securities that pay interest.

Sweep Account

1) The unusual structure of the Federal Reserve System is best explained by Americans' fear of centralized power.

TRUE

10) The FOMC issues directives to the trading desk at the New York Fed.

TRUE

13) Announcing the FOMC's policy decision immediately after the FOMC meeting is an example of how Fed policymaking has become more transparent.

TRUE

15) The Federal Reserve banks act as liaisons between the business community and the Federal Reserve System.

TRUE

16) The FOMC does not actually carry out securities purchases or sales.

TRUE

4) The FOMC is an element of the Federal Reserve System.

TRUE

5) All nationally chartered banks are required to be members of the Fed.

TRUE

6) Each member of the seven-member Board is appointed by the president and confirmed by the Senate to serve 14-year terms.

TRUE

7) The Board of Governors sets reserve requirements.

TRUE

Who jointly supervises state banks that have FDIC insurance but are not members of the Federal Reserve system?

The FDIC and the state banking authorities

Who has regulatory responsibility over bank holding companies and secondary responsibility for the national banks?

The Federal Reserve

Who has joint primary responsibility for state banks that are members of the Federal Reserve system?

The Federal Reserve and the state banking authorities

The most significant change in economic environment that alters the demand for financial products in recent years has been what?

The dramatic increase in the volatility of interest rates. -leads to a higher level of interest-rate risk -two examples of financial innovations that appeared in the 1970s confirm this prediction: the development of adjustable-rate mortgages and financial derivatives.

Federal Advisory Council

Twelve members (bankers), one from each FRB (selected by the directors of each FRB)

Supply in the Market for Reserves

Two components: non-borrowed reserves (Open Market Operations) and borrowed reserves (discount loans) Cost of borrowing from the fed is the discount rate Borrowing from the fed is a substitute for borrowing from other banks If iff<id, then banks will not borrow from the fed and borrowed reserves are zero: The supply curve will be vertical As iff rises above id, banks will borrow more and more at id (banks can borrow cheaper from the fed so have no reason to borrow from other banks) The supply curve is horizontal (perfectly inelastic) at id (banks only borrow from the fed)

What is the payoff method?

Used by the FDIC to handle a failed bank - the FDIC allows the bank to fail and pays off depositors up to the $250,000 insurance limit. After the bank has been liquidated, the FDIC lines up with other creditors of the bank and is paid its share of the proceeds from the liquidated assets

A bank that has no physical location but rather exists only in cyberspace.

Virtual Bank

When did the modern commercial banking industry in the United States begin?

When the bank of North America was chartered in Philadelphia in 1782

Easing of monetary policy

a lowering of the federal funds rate.

What is a subprime mortgage?

a new class of residential mortgages offered to borrowers with less-than-stellar credit crecords

Tightening of monetary policy

a rise in the federal funds rate.

Describe the originate-to-distribute business model

at each step of the securitization process, the loan originator, servicer, bundler and distributor earn a fee. Each of these four institutions has specialized in a particular element in the financial intermediation process.

What is the shadow banking system?

bank lending has been replaced by lending via the securities market, with the involvement of a number of different financial institutions

Deleveraging:

banks cut back on lending to borrowers

DFA Volcker Rule

banks limited in proprietary trading and ownership of hedge and private equity funds Purpose: limit trading risks for banks that benefit from FDIC

Banking crisis

banks unable to pay off creditors, some go out of business bank panic: depositors withdraw deposits and multiple banks fail simultaneously decreased availability of information, increased adverse selection and moral hazard problems

Why is adverse selection a problem with a government safety net like deposit insurance?

because people who are most likely to produce the adverse outcome the bank is insured against are the same people who most want to take advantage of the insurance

3 approaches to too big to fail

break up large sifis more regulation to reduce excessive risk taking dodd-frank good enough, nothing else

What does deposit insurance from the FDIC guarantee?

current depositors will be paid off in full on the first $250,000 they have deposited in a bank if the bank fails

Microprudential Supervision

focus on individual financial institutions, used before great recession

Major problem with CDOs

got so complex that it was difficult to value cash flows from underlying assets greater asymmetric info increased severity of adverse selection and moral hazard

What are capital requirements?

government-imposed capital requirements are another way of minimizing moral hazard at financial institutions

A change in the financial environment will stimulate a search by financial institutions for __________ that are likely to be profitable.

innovations

Uncertainty about interest−rate movements and returns is called​ ________.

interest-rate risk

Federal funds rate

is the interest rate on overnight loans from one bank to another.

What is one major problem with the too-big-to-fail policy?

it increases the moral hazard incentives for big banks

What is the most likely future of the structure of the U.S. banking industry?

it will still be unique, but not to the degree it once was. the consolidation surge will settle down as the U.S. banking industry approaches several thousand, rather than several hundred, banks.

Newly−issued high−yield bonds rated below investment grade by the bond−rating agencies are frequently referred to as....

junk bonds

Political business cycle

just before an election, expansionary policies are pursued to lower unemployment and interest rates.

What are adjustable-rate mortgages?

mortgages loans on which the interest rate changes when a market interest rate (usually the Treasury bill rate) changes

DFA Consumer Protection

new regulations on businesses that sell financial products to low income customers illegal for brokers to push borrowers into higher price loans state scan impose stricter consumer regulations on national banks permanently raises FDIC to $250,000

Case against Fed Independence

proponents of a Fed under the control of the President or Congress argue that is is undemocratic to have monetary policy (which affects almost everyone in the economy) controlled by an elite group that is responsible to no one.

Emergency Economic Stabilization Act (2008)

raised FDIC insurance limit to $250,000

Acquiring information on a​ bank's activities in order to determine a​ bank's risk is difficult for depositors and is another argument for government​ ________.

regulation

What is the too-big-to-fail problem?

regulators are reluctant to close down large financial institutions and impose losses on their depositors and creditors because doing so might precipitate a financial crisis

Define financial engineering

researching and developing new products and services that meet customer needs and prove profitable

The process of transforming otherwise illiquid financial assets into marketable capital market instruments is know as...

securitization

Securitization is a process of asset transformation that involves a number of different financial institutions working together. These financial institutions are known collectively as the...

shadow banking system

Collateralized Debt Obligations (CDO)

special purpose vehicle (SPV) buys colleciton of assets (MBS) and separates cash flows into tranches Highest rated tranches paid off first

DFA Derivatives

stdzd derivatives traded on exchanges and clear through clearing houses customized derivatives subject to higher capital requirements banks banned from dealing with risky derivatives firms dealing with derivatives subject to capital margin requirements and disclosure rule

Because of​ securitization, a new class of residential mortgages offered to borrowers with less−than−stellar credit records developed. These mortgages are known as...

subprime

Debt deflation

substantial unanticipated decline in price level sets in, leading to further decline in firm's net worth because increased burden of indebtedness

Money Multiplier definition

tells us how much the money supply changes for the given change in monetary base

What is the purchase and assumption method?

the FDIC reorganizes the bank, typically by finding a willing merger partner who takes over all of the failed bank's liabilities so that no depositor or other creditor loses money

Total Reserves (R) is equal to..(formula)

the Required reserve ratio(r)*total amount of check-able deposits(D) r*D=R

Assuming banks do not hold excess reserves the Required Reserve ratio(RR) is equal to what?

the Total Reserves held(R) Because R=RR+ER(excess reserves)

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.

Why is moral hazard an important concern for insurance arrangements?

the existence of insurance provides increased incentives for taking risks that might result in an insurance payoff

What is the most important source of the changes in supply conditions that stimulated financial innovation?

the improvement in computer and telecommunications technology (information technology)

What are the two methods the FDIC uses to handle a failed bank?

the payoff method and the purchase and assumption method

Define securitization

the process of bundling small and otherwise illiquid financial assets (such as residential mortgages, auto loans, and credit card receivables), into marketable capital market securities.

Open market operations

the purchase and sale of government securities that determines both interest rates and the amount of reserves in the banking system.

Case for Fed Independence

the strongest argument for an independent central bank rests on the view that subjecting it to more political pressure would impart an inflationary bias to monetary policy.

Systematically Important Financial Institutions (SIFI)

undesirable- extra regulation equals extra cost

In a​ ________ banking​ system, commercial banks provide a full range of​ banking, securities, and insurance​ services, all within a single legal entity.

universal