Unit 3: Chapters 14-16

Government and Federal Reserve emergency loans create moral hazard because there is a tendency

for financial services firms to take on greater risks because they assume they are at least partially insured against losses.

The Federal Open Market Committee (FOMC)

votes on the Fed's monetary policy and directs the purchase or sale of government securities.

TARP is the

Troubled Asset Relief Program funded with general tax revenue and the issuance of government debt.

Each member of the Board of Governors is selected by the __________________________.

U.S. president and confirmed by the Senate

Checkable deposits are included in: A. both M1 and M2 B. M1 but not in M2 C. M2 but not in M1 D. neither M1 nor M2

a

Traditionally, the Fed often communicated its intentions to restrict or expand monetary policy by announcing a change in its target for the: A. Federal funds rate B. Consumer price index C. Discount rate D. Prime rate

a

The major categories of firms that make up the U.S. financial services industry include

commercial banks, thrifts, insurance companies, and securities-related firms.

How does the purchasing power of money relate to the price level?

It is inversely related to the price level

The following are two hypothetical ways in which the Federal Reserve Board might be appointed. a. Upon taking office, the U.S. president appoints seven people to the Federal Reserve Board, including a chair. Each appointee must be confirmed by a majority vote of the Senate, and each serves the same 4-year term as the president. b. Congress selects seven members from its ranks (four from the House of Representatives and three from the Senate) to serve at congressional pleasure as the Board of Governors of the Federal Reserve System. In the opinion of most economists, which option would be favored?

Neither option is ideal because the independence of the Fed would be compromised

What are the three basic functions of money?

medium of exchange, unit of account, store of value

Mortgage-backed securities were one of the factors that exacerbated the financial crisis of 2007-2008 because they

reduced the risk exposure that banks faced after issuing these subprime loans, which encouraged this type of lending.

When economists say that the Federal Reserve Banks are quasi-public banks, this means

they are a blend of private ownership and public control.

Merchants accepted gold receipts as a means of payment even though the receipts were issued by goldsmiths, not the government, because

they knew that the gold receipts could be exchanged for gold.

Consider the following statement: In the United States, the debts of government and commercial banks are used as money.This statement acknowledges that ________________________.

accounts in commercial banks are customer deposits and thus are debts of commercial banks.

A bank is in the position to make loans when required reserves: A. Equal actual reserves B. Equal excess reserves C. Are less than actual reserves D. Are greater than actual reserves

c

A bank's required reserves can be calculated by: A. Multiplying its checkable-deposit liabilities by its excess reserves B. Dividing its excess reserves by its required reserves C. Multiplying its checkable-deposit liabilities by the reserve ratio D. Dividing its required reserves by its excess reserves

c

Other things equal, an appreciation of the U.S. dollar would: A. Increase the prices of imported resources and decrease aggregate supply B. Increase productivity and increase aggregate supply C. Decrease net exports and decrease aggregate demand D. Decrease the supply of money and decrease aggregate demand

c

When paper money is designated as legal tender, it means that: A. It will be accepted by the government B. Its supply is controlled by the government C. It is a means of payment by law D. It is printed by the government

c

The interest rate that the Fed charges banks for loans to them through the traditional channel is called: A. The prime rate B. Interest on reserves C. The discount rate D. The federal funds rate

c.

The Federal Reserve Board of Governors: a. is the largest bank in the United States. b. is replaced every 2 years. c. coordinates policies for the 12 Federal Reserve Banks. d. is made up of five members.

c. coordinates policies for the 12 Federal Reserve Banks.

Compared to a decade ago, there are a. smaller bank firms. b. more bank firms. c. fewer bank firms. d. more regulated bank firms.

c. fewer bank firms.

Answer the question based on the following consolidated balance sheet for the commercial banking system. Assume the required reserve ratio is 12 percent. All figures are in billions of dollars: ASSETS($) LIABILITIES + NET WORTH($) Reserves = 60 Checkable Deposits = 150 Loans = 100 Stock Shares = 135 Securities = 25 Property = 100 Refer to the above data. The claims of owners in the commercial banking system are equal to: A. $150 billion B. $100 billion C. $60 billion D. $135 billion

d

Diversification in one's investments reduces: A. Pooling risk B. Time preference risk C. Systemic risk D. Idiosyncratic risk

d

Which of the following actions by the Fed would cause the money supply to increase? a. an increase in the reserve requirement b. sales of government bonds to the public c. an increase in the discount rate d. purchases of government bonds from banks

d

Which of the following functions of money enables society to gain the benefits of geographic and labor specialization? A. Medium of deferred payment B. Unit of account C. Store of value D. Medium of exchange

d

Which of the following would best be a brief definition of present value? A. Assets minus liabilities incurred to acquire the assets B. The sum of all the past values of an asset C. Benefits of an minus its costs D. The current value of the expected future returns on an asset

d

Which one of the following is an example of a financial investment but not an economic investment? A. An addition to a petroleum refinery B. A renovation of a shopping mall C. Building a new store D. Buying gold to sell later at a higher price

d

What are the components of the M1 money supply? a. Savings deposits and checkable deposits b. Currency in circulation and checkable deposits c. Currency in circulation and savings deposits d. ATM deposits and checkable deposits

b

The multiple by which the commercial banking system can expand the supply of money is equal to: A. The reciprocal of the reserve ratio B. The reciprocal of the federal funds rate C. The ratio of actual reserves to required reserves D. The ratio of required reserves to actual reserves

a

Which one of the following is a feature of all investments? A. They give owners a chance to receive future payments B. They have minimal risk for future payments to be made C. They provide regular interest payments D. They are typically long term

a

Suppose the price level and value of the U.S. Dollar in year 1 are 1 and $1, respectively. a. If the price level rises to 1.55 in year 2, what is the new value of the dollar? b. If, instead, the price level falls to 0.35, what is the value of the dollar?

a. $ 0.65 New Value of the Dollar = Initial Value / New Price Level New Value of the Dollar = 1 / 1.55 = $ 0.65 b. $ 2.86 1 / 0.35 = $ 2.86

Suppose that Lady Gaga goes to Las Vegas to play poker and at the last minute her record company says it will reimburse her for 50 percent of any gambling losses that she incurs. a. Will Lady Gaga wager more or less as a result of the reimbursement offer? b. What economic concept does your answer illustrate?

a. More b. Moral Hazard

Which of the following statements is true? a. There is no concrete backing to the money supply in the United States. b. The gold standard applies to a small fraction of the money supply. c. Half the money supply is backed by gold. d. The money supply is backed by Treasury notes.

a. There is no concrete backing to the money supply in the United States.

Subprime mortgage loans were one of the factors that exacerbated the financial crisis of 2007-2008 because they resulted in

an increase in demand for housing and a rapid increase in home prices that was unsustainable.

AMOUNT OF MONEY DEMANDED ($B) INTEREST RATE a. 50 5 b. 100 4 c. 150 3 d. 200 2 e. 250 1 f. 300 0 Refer to the graph above. If the equilibrium interest rate is 4 percent, the supply of money must be: A. $200 billion B. $100 billion C. $250 billion D. $150 billion

b

If the Fed wants to maintain current interest rates, it would be buying government bonds in the open market when: A. The discount rate increases B. The demand for money increases C. Investment demand decreases D. The demand for money decreases

b

If the required reserve ratio is 20 percent and commercial bankers decide to hold additional excess reserves equal to 5 percent of any newly acquired checkable deposits, then the effective monetary multiplier for the banking system will be: A. 6 B. 4 C. 5 D. 3

b

Roger has the opportunity to invest $100,000 in two different assets. The investment in Asset #1 will have a present value of $120,000. The investment in Asset #2 is expected to have a future value of $140,000 in four years. If the market interest rate is 5 percent a year, which one would be the better investment? A. Asset #1, because its present value is greater than the future value of Asset #2 B. Asset #2, because its present value is greater than the present value of Asset #1 C. Asset #1, because its present value is greater than the present value of Asset #2 D. Asset #2, because its future value is greater than the present value of Asset #1

c

The so-called too-big-to-fail policy has two conflicting sides: on one hand there's the moral hazard problem that it creates, but in the other hand the Fed must: A. Ensure the employment of people in financial services B. Control the money supply C. Protect the stability of the banking system D. Promote competition among banks

c

A key reason that actively managed funds have lower returns than index funds with a similar level of risk is that: A. Index funds spend more on research and management B. Diversification is more important to actively managed funds C. Index funds require more buying and selling to generate their returns D. Management and trading costs reduce the returns of actively managed funds

d

The Fed can induce banks to increase their reserve holdings by: A. Increasing the discount rate B. Reducing the required reserve ratio C. Selling securities in the open market D. Increasing the interest on reserves

d

The ultimate objective of an expansionary monetary policy is depicted by: a. a decrease in the money supply from Sm3 to Sm2. b. a reduction of the interest rate from 8 to 6 percent. c. an increase in investment from $20 billion to $25 billion. d. an increase in real GDP from Q1 to Qf.

d

What does "there is no such thing as a free lunch" mean in economics? A. That products only have value because people are willing to pay for them B. That sometimes people may take friends out to lunch and pay for them C. That all items in the lunch menu have specific prices D. That scarce resources are used up to provide "freebies" and giveaways

d

What is a major opportunity cost of going to college on a full-time basis? A. The cost of living expenses (room and board) to attend college B. The cost of transportation to college instead of to a job C. The greater income that will be earned from having a college degree D. The foregone income that could be earned working full-time job

d

What is one of the advantages of monetary policy over fiscal policy? A. Its control over the size of Federal budget deficits B. The opportunity for broad political influence C. It can guarantee an expansion of aggregate demand when needed D. The quickness with which it can be used

d

Between 1980 and 2007, the bank and thrift share of the financial services market

declined substantially

Consider the following statement: When the price of everything goes up, it is not because everything is worth more but because the currency is worth less.This statement acknowledges that _______________________.

if the price of everything rises, it means the currency has less purchasing power.

Other than its main role of controlling the supply of money, the functions of the Federal Reserve include

issuing Federal Reserve Notes, providing for check collection, and supervising the operation of banks.

American International Group (AIG) exacerbated the financial crisis of 2007-2008 by

issuing billions of dollars of collateralized default swaps that had embedded mortgage-loan risk.

Consider the following statement: The invention of money is one of the great achievements of humankind, for without it the enrichment that comes from broadening trade would have been impossible.This statement acknowledges that

without money, trade must occur through barter, which is inefficient and cumbersome.

The asset demand for money is most closely related to money functioning as a

store of value

When economists say that the Federal Reserve Banks are central banks, this means

the policies are coordinated by the Federal Reserve Board of Governors.

When economists say that the Federal Reserve Banks are bankers' banks, this means

they perform the same functions for banks as banks perform for the public.

Economists nearly uniformly support an independent Fed rather than one beholden directly to either the president or Congress because

this independence allows the Fed to more effectively control the money supply and maintain price stability

Consider the following statement: Money is whatever society says it is.This statement acknowledges that money _______________________________.

Must be an acceptable medium for exchange to occur

What near-monies are included in the M2 money supply?

Noncheckable savings deposits, money market deposit accounts, small time deposits, and money market mutual fund balances

Why is the face value of a coin greater than its intrinsic value?

People would sell it for its intrinsic value

Who in the United States is responsible for maintaining money's purchasing power?

Board of Governors of the Federal Reserve System

Changes in interest rates, ceteris paribus, cause a shift in: A. The investment demand curve and the aggregate demand curve B. Neither the investment demand curve nor the aggregate demand curve C. The aggregate demand curve, but not the investment demand curve D. The investment demand curve, but not the aggregate demand curve

C

Monetary policy is expected to have its greatest impact on

C (gross investment)

What's the largest component of M1?

Checkable Deposits

Which of the components of M1 is legal tender?

Currency

What determines the value (domestic purchasing price) of money?

People's willingness to accept it in exchange for goods and services.

The categories of financial firms have become more blurred as these firms are trying to

retain their market

Assume that securitization combined with borrowing and irrational exuberance in Hyperville have driven up the value of existing financial securities at a geometric rate, specifically from $6 to $12 to $24 to $48 to $96 to $192 over a six-year time period. Over the same period, the value of the assets underlying the securities rose at an arithmetic rate from $6 to $9 to $12 to $15 to $18 to $21. If these patterns hold for decreases as well as for increases, by how much would the value of the financial securities decline if the value of the underlying asset suddenly and unexpectedly fell by $15?

$ 186 $ 192 - $6 = 186

Assume that securitization combined with borrowing and irrational exuberance in Hyperville have driven up the value of existing financial securities at a geometric rate, specifically from $2 to $4 to $8 to $16 to $32 to $64 over a six-year time period. Over the same period, the value of the assets underlying the securities rose at an arithmetic rate from $2 to $3 to $4 to $5 to $6 to $7. Instructions: Enter your answer as a whole number. If these patterns hold for decreases as well as for increases, by how much would the value of the financial securities decline if the value of the underlying asset suddenly and unexpectedly fell by $5?

$ 62 64 - $2 = 62

Rapid inflation can undermine money's ability to perform its functions. For example, in runaway inflation

people revert to barter because money fails as a medium of exchange.

In the recent financial and economic crises, the economy fell into a so-called liquidity trap, which means that: A. Banks held on to excess reserves and people chose to pay off loans rather than spend B. Banks did not have enough reserves to continue lending to banks C. Firms did not want to borrow from banks because they had little need for extra liquidity D. The Fed injected reserves into the banking system, but the interest rates remained high

a

The major problem facing the economy is high unemployment and weak economic growth. The inflation rate is low and stable. Therefore, the Federal Reserve decides to pursue a policy to increase the rate of economic growth. Which policy changes by the Fed would tend to offset each other in trying to achieve that objective? A. Buying government securities and raising the discount rate B. Buying government securities and lowering the reserve ratio C. Selling government securities and raising the reserve ratio D. Selling government securities and raising the discount rate

a

What is one significant characteristic of fractional reserve banking? A. Banks can create money through lending their reserves B. Bank loans will be equal to the amount of gold on deposit C. Banks use deposit insurance for loans to customers D. Banks hold a fraction of their loans in reserve

a

Which of the following are liabilities to a bank? A. Demand and time deposits B. Vault cash and demand deposits C. Capital stock and reserves D. Property and capital stock

a

Which of the following varies directly with the interest rate? A. The opportunity cost of holding money B. The asset demand for money C. The transactions demand for money D. The level of investment

a

Suppose the price level and value of the U.S. Dollar in year 1 are 1 and $1, respectively. a. If the price level rises to 1.25 in year 2, what is the new value of the dollar? b. If, instead, the price level falls to 0.50, what is the value of the dollar?

a. $ 0.8 New Value of the Dollar = Initial Value / New Price Level New Value of the Dollar = 1 / 1.25 = $ 0.8 b. $ 2.00 1 / 0.50 = $ 2.00

CATEGORY VALUE Federal Reserve notes in Circulation 700 Money Market Mutual Funds (MMFs) held by individuals 400 Corporate bonds 300 Iron Ore Deposits 50 Currency in Commercial Banks 100 Savings deposits, including money market deposit accounts (MMDAs) 140 Checkable Deposits 1500 Small-denominated (less than $100,00) time deposits 100 Coins in Circulation 40 Instructions: Enter your answers as whole numbers. a. What is M1 in Ironmania? b. What is M2 in Ironmania?

a. = $2240 million M1 = Notes in Circulation + Coins + Checkable Deposits M1 = 700 + 40 +1500 M1 = $ 2240 b.$ 2880 million M2 = M1 + Saving Deposits + Time Deposits + MMF M2 = 2240 + 140 + 100 + 400 M2 = $ 2280

Which of the following are included in the functions of the Federal Reserve System? a. Issuing Federal Reserve Notes, providing for check collection, and supervising the operation of banks b. Overseeing government transactions, providing for check collection, and supervising the operation of banks c. Performing economic projections, providing for check collection, and supervising the operation of banks d. Issuing Federal Reserve Notes, overseeing government transactions, and performing economic projections

a. Issuing Federal Reserve Notes, providing for check collection, and supervising the operation of banks

Suppose that Lady Gaga goes to Las Vegas to play poker and at the last minute her record company says it will reimburse her for 20 percent of any gambling losses that she incurs. a. Will Lady Gaga wager more or less as a result of the reimbursement offer? b. What economic concept does your answer illustrate?

a. More b. Moral Hazard

One reason that "near-monies" are important is because: A. Credit cards synchronize one's expenditures and income, thereby reducing the cash and checkable deposits one must hold B.They can be easily converted into money or vice versa, and thereby can influence the stability of the economy C. They simplify the definition of money and therefore the formulation of monetary policy D. They do not reflect the level of consumer spending but they have a critical impact on saving and investment in the economy

b

Which of the following does not explain what backs the money supply in the United States? a. It is relatively scarce. b. It is backed by gold. c. It is designated "legal tender" by the federal government. d. It is widely accepted in transactions.

b

If the monetary multiplier is 6, then the reserve ratio must be: A. 0.06 B. 0.167 C. 0.6 D. 1.67

b. 0.167 (1 / 6 = 0.167)

A commercial bank sells a $10,000 government bond to a securities dealer. The dealer pays for the bond in cash, which the bank adds to its vault cash. The money supply has: A. Increased by $10,000 B. Decreased by $10,000 multiplied by the reciprocal of the required reserve ratio C. Decreased by $10,000 D. Not been affected

c

A depositor places $5,000 in cash in a commercial bank, and the reserve ratio is 20 percent; the bank sends the $5,000 to the Federal Reserve Bank. As a result, the reserves and excess reserves of the bank have been increased, respectively, by: A. $4,000 and $4,000 B. $5,000 and $5,000 C. $5,000 and $4,000 D. $5,000 and $1,000

c

A wealthy executive is holding money, waiting for a good time to invest in the stock market. This action would be an example of the: A. Creation of fiat money B. Transactions demand for money C. Asset demand for money D. Use of money as a medium of exchange

c

If the price index rises from 100 to 130, then the purchasing power of the dollar will fall by about: A. 30 percent B. 15 percent C. 23 percent D. 19 percent

c

In the cause-effect chain linking changes in the banks' excess reserves and the resulting changes in output and employment in the economy: A. A decrease in excess reserves will increase the money supply B. A decrease in aggregate demand will increase output C. An increase in the money supply will decrease the rate of interest D. A decrease in the rate of interest will decrease aggregate demand

c

Which of the following is not true about the use of a credit card? A. It is a means of deferring payment for a short period of time B. It allows people to "economize" on the use of money C. Credit-card balances are part of M2, but not part of M1 D. A credit card transaction is not the same as a debit card transaction

c.

Consider the following statement: Any central bank can create money; the trick is to create enough, but not too much, of it.This statement acknowledges that a central bank _____________________________.

can create too much money, lowering its value and causing inflation

The Federal Open Market Committee (FOMC) includes

members of the Board of Governors and 5 of the 12 presidents of the Federal Reserve Banks, of which the president of the New York Fed has a permanent voting seat.

Consider the following statement: People often say they would like to have more money, but what they usually mean is that they would like to have more goods and services.This statement acknowledges that ______________________.

money can be used to purchase goods and services, but as an asset money provides little return.

The financial crisis of 2007-2008 was exacerbated by subprime mortgage loans. These loans were made to borrowers _______________________.

more likely to default on their loans.

A $70 price tag on a sweater in a department store window is an example of money functioning as a

unit of account f

The Federal Reserve serves as "lender of last resort." In the financial crisis of 2007-2008, this meant that it

used creative facilities to lend to financial institutions in the emergency