Ch 15 Money and Banking

Briefly explain​ why, with the monetary policy tools it had used prior to the financial​ crisis, the Fed could not control the federal funds rate.

- After excess reserves became​ abundant, changes in reserves due to open market operations led to almost no movement in the federal funds rate.

Why does an increase in the federal funds rate decrease the quantity of reserves demanded?

- As the federal funds rate increases, the opportunity cost to banks of holding excess reserves increases because the return they could earn from lending out those reserves goes up.

At what interest rate does the demand curve for reserves become perfectly elastic?

- At the interest rate the Fed pays on banks' reserve balances.

What legislative change and financial innovations occurred after 1979 that changed M1 from representing a pure medium of exchange to also representing a store of​ value?

- Banks developed automated transfer of saving​ accounts, which move checkable deposit balances into​ higher-interest CDs each night and then back into checkable deposit balances in the morning. - Congress authorized NOW accounts on which banks ban pay interest.

What does Yellen mean by​ "reserves were no longer relatively​ scarce"?

- Before the financial crisis, banks chose to hold relatively low levels of excess reserves, but since the 2007-2009 financial crisis, banks are choosing to hold significantly more excess reserves.

Which groups would likely benefit from deflation? Which group would likely be hurt?

- Creditors would likely gain from deflation and borrowers would likely lose.

Why doesn't the IOER serve as a floor for the effective federal funds rate?

- Financial firms not eligible to receive the IOER may be willing to lend at rates lower than the IOER.

How does the rate on ON RRP transactions serve as a floor for the federal funds rate?

- Financial firms receiving the ON RRP are typically unwilling to lend in the federal funds market at a lower rate.

Why would anyone buy a bond with a negative interest​ rate?

- Institutions needing a safe place to put large sums of money would pay negative interest rates because it would be costly for them to protect the money themselves.

Given the subsequent crash of technology stocks, why might the Fed have not intervened during this period of time?

- It was difficult to determine whether an asset bubble existed.

Why would this change in M1 break the short-run link between money and inflation?

- M1 became more a store of value than a pure medium of exchange.

Which from the following variables is most likely to be an intermediate target of monetary policy?

- Monetary base - M2 - M1

Is it likely that the Fed would be able to set the interest rate it pays banks on reserves equal to the actual federal funds rate?

- No, because the Fed does not control the federal funds rate-it only influences it through its policy decisions.

Given that inflation erodes the value of​ money, should the Federal Reserve pursue a goal of deflation?

- No, deflation encourages consumers to delay consumption, which can cause the economy to contract

Is every financial firm that can participate in ON RRP transactions is also eligible to receive the IOER?

- No, government-sponsored enterprises like Fannie Mae and Freddie Mac are not eligible to receive the IOER.

Which from the following variables is most likely to be an operating target of monetary​ policy?

- Nonborrowed reserves - Federal funds rate

Which from the following variables is most likely to be a monetary policy​ tool?

- Open market purchases - Discount rate

This statement shows the FOMC using a monetary policy tool. Briefly explain which monetary policy tool it was.

- Open market​ operations, since the Fed plans to keep buying securities to keep the federal funds rate at its target rate.

Which from the following variables is most likely to be a goal of monetary policy?

- Real GDP growth - Unemployment rate

Why would anyone refer to an investor as out of touch if he wasn't investing in technology stocks in 1999 and early 2000?

- Technology stocks were rising with the dot-com boom.

What are the reasons banks demand reserves?

- To meet their legal obligation to hold required reserves. - To hold excess reserves to meet their short-term liquidity needs.

How can the FOMC use open market operations to raise its target for the federal funds rate?

- To raise its target for the federal funds rate, the Fed can conduct an open market sale of securities.

Would deflation create some of the same problems as inflation in terms of the information communicated by price changes and the arbitrary redistribution of income?

- Unanticipated deflation redistributes income just as unanticipated inflation does, but from borrowers to lenders rather than from lenders to borrowers. - Deflation, just like inflation, complicates the ability to distinguish overall price changes from relative price changes, which determine resource allocation.

In 2019, a Federal Reserve publication stated: "The Federal Reserve can no longer effectively influence the FFR by small changes in the supply of reserves." Is this statement true?

- Yes, since the 2007-2009 financial crisis, banks have held substantial excess reserves, so small changes in reserves by the Fed do not significantly influence the FFR.

If the Fed uses the federal funds rate as a policy instrument, then increases in the demand for reserves will lead to _____ in the level of reserves.

- an increase

If the Fed uses the level of reserves as policy instruments, then increases in the demand for reserves will lead to _____ in the federal funds rate.

- an increase

If the interest rate on reserves moves above the federal funds rate, then _____.

- banks would prefer to sit on their excess reserves instead of lending to other banks in the federal funds market.

What is the difference between the IOER and the rate on ON​ RRP? The IOER is the interest rate paid on​ ________, while the ON RRP is the interest rate paid on​ ________.

- banks' reserve balances; overnight repurchase agreements

To offset the effect on the federal funds rate of increase in the demand for reserves, the Fed could ____ securities.

- buy

From the most influence to the least influence:

- policy tools, policy instruments, intermediate targets, and policy goals.

What is an open market operation? Why does the Fed engage in open market operations?

An open market operation is when the Fed buys or sells securities in the financial markets. The Fed engages in open market operations in order to influence bank reserves and short-term interest rates.

Federal funds rate target

Current inflation rate + Equilibrium real federal funds rate + ​(1/2 × (current inflation - target inflation) +​(1/2 × Output gap))

Briefly describe the procedure the Fed follows in implementing them.

The need for open market operations is determined by the Federal Open Market Committee (FOMC), while the execution of the open market operation in conducted by the Federal Reserve Bank of New York.