Econ 2035 exam 3
Before the financial crisis of 2007-2009, what were the monetary policy tools that the Fed relied on?
discount policy, reserve requirements, open market operations
If this assumption were incorrect, then the central bank would be able to control the money supply through changes in the monetary base __________________ changes in the money multiplier.
and
The Fed was initially tasked to ________. Since that time, the responsibilities of the Fed have ________.
provide short-run liquidity to banks, oversee the banking system, and manage the money supply; expanded greatly
Michael McAvoy's explanation of how the Federal Reserve Bank cities were selected is more consistent with a _______ of how the decision was made since he finds that locations were determined based on _______.
public interest view; sound economic reasons
Economic well-being is typically determined by the
quantity and quality of goods and services that individuals can enjoy.
Why did the United States have no central bank between 1836 and 1913?
the authorization for a central bank expired
The behavior of which three groups is included in the money supply process?
the banking system, the federal reserve, the nonbank public
What are agency residential and commercial mortgage-backed securities (MBS)?
Securities that are issued by government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac
In what ways does the Fed's purchases of Treasury securities and mortgage-backed securities lead to "smooth market functioning"?
Sellers of these securities can find buyers and can, therefore, continue to fund their operations.
What are the arguments for a Federal Reserve Bank operating independently?
A regional Federal Reserve Bank acting independently can act quickly to address regional issues.
What are the arguments against a Federal Reserve Bank operating independently?
A regional Federal Reserve Bank's actions might exacerbate a crisis. A regional Federal Reserve Bank would be circumventing the checks and balances built into the system.
What is the public interest view of the Fed's motivation?
A theory of central bank decision making that holds that officials act in the best interests of the public.
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 are repurchase agreements?
A short-term loan backed by collateral such as U.S. Treasury notes
Which groups would likely benefit from deflation? Which groups would likely be hurt? _______ would likely gain from deflation and ______ would likely lose
Creditors; borowers
When examining the Fed's balance sheet, in most periods, the two most important liabilities are:
Currency in circulation and Reserve balances of banks.
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?
Deflation, just like inflation, complicates the ability to distinguish overall price changes from relative price changes, which determine resource allocation. Unanticipated deflation redistributes income just as unanticipated inflation does, but from borrowers to lenders rather than from lenders to borrowers.
do open market operations imply?
The purchase or sale of securities, typically U.S. Treasury securities, in financial markets
Which of the following is not one of the three categories of discount loans?
emergency credit
The need for open market operations is determined by _____________ while the execution of the open market operation is conducted by ______________
federal open market committee the federal reserve bank of New York
If the currency−to−deposit ratio (C/D) decreases, the money multiplier will
increase
A reduction in the reserve ratio would _____________ the money multiplier. A reduction in currency in circulation would __________ bank reserves. Both of these factors would ____________ the money multiplier, __________ the money supply while the monetary base __________
increase; increase; increase; increasing; remained the same
The Fed doesn't seek to reduce the unemployment rate to zero because the tools of monetary policy are
ineffective in reducing the level of frictional unemployment.
If the Fed uses these two new monetary policy tools to manage the federal funds rate, it can lower its target rate by _______.
lowering the interest rate it pays on overnight reverse repurchase facilities decreasing the interest rate it pays on banks' excess reserves
What is the relationship between the federal funds rate and the interest rates on 30-year mortgages and on Aaa and Baa rated corporate bonds? These rates generally ________.
move together, although the federal funds rate often increases and decreases more than these long-term rates.
Deflation would be "potentially highly damaging" because of all of the following EXCEPT?
It would make prices fall, so goods would become less expensive.
Why do fluctuations in interest rates make investment decisions by households and firms more difficult?
Because the cost of borrowing becomes more uncertain.
Why does the supply curve have a horizontal segment?
Because the discount rate sets a ceiling on the federal funds rate.
Was Fed Chairman Bernanke justified in evading the requirements of this act during the financial crisis of 2007-2009?
Because the financial crisis was unfolding so quickly, one could argue that Bernanke was justified in evading the Sunshine Act.
Explain whether you agree with the following observation: "Since March 2020, the required reserve ratio has been equal to 0, therefore any increase in the monetary base can lead to an infinite increase in the money supply.
Disagree. If the required reserve ratio equaled zero, the simple deposit multiplier would equal infinity, implying that multiple deposit expansion would go on forever. However, the realistic money multiplier, which includes currency and excess reserve holdings, would not equal infinity even if the required reserve ratio equaled zero.
Why would the Fed's buying Treasury securities and mortgage-backed securities keep "financial market conditions easy"?
It increases bank reserves, resulting in lower interest rates, making it easier to borrow and spend in the economy.
Is it easier for a central bank to be independent in a high-income country or in a low-income country?
It is often difficult for a central bank to act independently in a low-income country.
What is the simple deposit multiplier?
It is the ratio of the amount of deposits created by banks to the amount of new reserves.
When economists speak of the "zero lower bound problem" that the Fed sometimes faces, what are they referring to?
It is when short-term interest rates are close to zero, meaning the Fed can no longer use changes in interest rates to stimulate the economy.
What was the effect on banks of the fed's decisions to increase the required reserve ratio
It reinforced monetary contraction and it lowered the money multiplier
What is the likeliest explanation for why the arrival in Argentina of the Covid-19 pandemic resulted in an increase in the country's monetary base?
Its central bank was likely purchasing large amounts of government securities, causing its balance sheet to expand.
What is the main problem with having a central bank that is not independent of the rest of the government?
Less independent central banks tend to lead to higher inflation. An independent central bank can more freely focus on keeping inflation low.
]Which of the following is NOT a supportive argument that the Fed's dual mandate should be replaced with a single mandate of price stability?
Monetary policy can sometimes be used to stimulate the economy quickly in times of large decreases in demand which can reduce unemployment in the economy.
What are the main arguments for the Fed's independence?
Monetary policy is too important to be left to politicians, who are not economists and have their own political interests at stake. An independent Fed makes a political business cycle less likely.
As of March 2020, the Fed no longer required banks to hold required reserves. Did that change mean that after March 2020, the monetary base consisted only of currency in M1?
No, banks still hold reserves, especially large banks that need to satisfy the Basel accord requirements.
Do the funds the Fed uses to buy Treasury bonds represent "new money"? If not, how does the money supply increase as a result of the Fed buying Treasury bonds?
No, the money supply grows as a result of the money multiplying process through continual deposits and loans.
In the modern Fed, would it be possible for a Reserve Bank to act as the New York Fed did in 1929?
No. In the modern Fed a Reserve Bank cannot conduct monetary policy independent from the FOMC and the Board of Governors.
This statement shows the FOMC using a monetary policy tool. Briefly explain which monetary policy tool it was. (too long)
Open market operations, since the Fed plans to keep buying securities to keep the federal funds rate at its target rate.
What are the new tools the Fed has used in recent years when facing the zero lower bound problem?
Purchasing long-term securities—quantitative easing Providing insight on future Fed policies—forward guidance
Which of the following might be a reason to explain the difficultly in identifying inflated asset prices?
Reasonable investors can have widely varying expectations of future profitability.
What implications does your answer have for what the average inflation rate is likely to be in high-income countries as opposed to low-income countries?
Research has shown that the more independent a central bank is, the lower the inflation rate will be. Thus, one would expect the average inflation rate in less-developed countries to be higher than in industrial countries.
Why did Congress set up a system that had this tension between the Reserve Banks and the Federal Reserve Board?
Tension was created to ensure that various interests would have input into the conduct of monetary policy. Your answer is correct. This was all part of the organizational plan to prevent one faction of the banking system from having too much power.
In what sense is the Federal Reserve System both accountable to the government and independent of it?
The Board of Governors is a federal government agency, while the Federal Reserve Banks are legally the equivalent of private corporations.
Which body is more important within the Federal Reserve System, the Board of Governors or the Federal Open Market Committee?
The Board of Governors since they control reserve requirements, the discount rate, and hold a majority of the seats on the Federal Open Market Committee.
In what ways is the Fed subject to external pressure?
The Congress can amend the Fed's charter and powers or even abolish it entirely. The president can exercise control over the membership of the Board of Governors and appoint a new chairman every four years.
Why is the process of the multiple expansion of deposits so important to understanding how the banking system operates?
The Fed can accurately control the monetary base, however, the Fed does not control the actions of the other particpants in the money supply process which is greatly affected by the banking system. Banks play a large role in the economy as a major source of lending to most borrowers. Since banks make so many loans, the effects from these create additional impacts in the banking system. Because the monetary system operates under a fractional-reserve banking system, banks can create money on their own through the deposit creation process.
If the Fed wishes to contract the total value of checkable deposits in the banking system, what action can it take?
The Fed can sell Treasury bills to financial institutions.
Why does the Fed set the discount rate higher than the federal funds rate?
The Fed sets the discount rate higher because it wants to be considered the lender of last resort.
Prior to 2007, the Fed's securities purchases were primarily short-term Treasury securities, such as T-bills. Why did the Fed begin purchasing mortgage-backed securities?
The Fed wanted to push down the interest rate on mortgages to make it easier for people to buy houses.
What is the purpose of the Government in the Sunshine Act?
The Government in the Sunshine Act, which required government agencies to post meetings before they happened, was created to promote public awareness.
The same publication refers to "the banking system's ability to multiply loans and deposits with the individual bank's inability to do so." Which of the following is NOT a reason the banking system is able to multiply loans and deposits when an individual bank is unable to do so?
The banking system is directly controlled by the Fed. Therefore, the amount of lending and deposits are directly determined by Fed policy.
Has the tension been resolved in the modern Fed?
The board has much more power today, but the tension remains.
If the banks were holding excess reserves for reasons of safety, why might the Fed's staff have been overestimating potential monetary and credit expansion?
The fed assumed that banks would loan out these excess reserves
Why does the Fed charge different interest rates on the three categories of discount loans?
The interest rates are based on the level of risk associated with the banks seeking funds.
A Federal Reserve publication notes that when economists analyze the money supply process, they typically assume that the money multiplier is "independent of the policy actions of the central bank." Briefly explain what this assumption means?
The money multiplier is determined by a variety of factors over which the central bank has no control.
A theory of central bank decision making that holds that officials act in the best interests of the public.
The political business cycle would be more likely with the principal-agent view where the Fed lowers interest rates to stimulate the economy before an election to avoid conflict with groups that could limit its power and influence.
What are the main arguments against the Fed's independence?
The public is unable to hold Fed officials accountable for their policies, unlike elected officials. It would be more democratic for elected officials to control monetary policy.
If you owned a firm that did business internationally, why would excess fluctuations in the foreign exchange value of the dollar make planning for business and financial transactions more difficult?
They make it difficult to know the dollar value of foreign assets. They make it difficult to know the cost of imported intermediate goods. They make it difficult to know the cost of your products abroad.
Why might banks in the mid-1930s have been holding reserves for "reasons of safety"?
They were holding reserves to guard against bank runs.
Gary Richardson of the University of California, Irvine observed in a Federal Reserve publication that, "The flaws in the Federal Reserve's structure became apparent during the initial years of the Great Depression." What is he referring to with this statement?
The Fed's power was initially too decentralized, spread across 12 districts, to respond effectively to a national crisis.
Why does the Fed's purchase of Treasury bills lead to "multiple deposit creation"?
The Fed's purchase of Treasury bills increases the amount of reserves at banks.
Explain the effect on the demand for reserves or the supply of reserves of the following Fed policy action: An increase in the interest rate paid on reserves.
This would raise the interest rate at which the demand curve becomes horizontal.
What are the reasons banks demand reserves?
To hold excess reserves to meet their short-term liquidity needs. To meet their legal obligation to hold required reserves.
If there is a conflict of interest in the governance structure of the Federal Reserve Banks, why did Congress establish this structure when it passed the Federal Reserve Act in 1913?
To prevent one constituency from exploiting the central bank's economic power at the expense of another constituency.
An article on marketwatch.com in mid-2020 observed: "Growth in the balance sheet has been slowing as the Fed has tapered the pace of its asset purchases." What types of asset purchases is the article referring to? The article is referring to the Fed's purchases of ________.
US treasury securities
What does the editorial mean by "pricing and allocating capital"? In what way does buying corporate bonds involve a central bank in pricing and allocating capital?
When a central bank buys bonds, it increases the demand for bonds, causing bond prices to rise and their interest rates to drop.
When Congress gave the Fed a dual mandate, why did they choose these two monetary policy goals?
When the Fed achieves these two policy goals, it usually also leads to achieving its other goals.
Thomas Hoenig, former president of the Federal Reserve Bank of Kansas City, remarked about the Federal Reserve System that: "[I]t was designed as a public-private partnership, accountable to, and yet independent of, the government." Part 2 In what sense is the Federal Reserve System a "public-private partnership"?
While authorized by the government, it is owned by private banks.
An opinion column on barrons.com, discussing the conflict between President Trump and Fed Chair Jerome Powell, observed: "Leave aside the arguments over policy for a moment. Consider instead the Constitutional question of an unelected agency of government officials working to thwart the policies of elected officials." Is it correct to describe the Fed as "an unelected agency of government officials"?
Yes, it is true that Fed officials are not elected, so in some sense the quote is correct.
why did Congress decide to establish the Federal Reserve System in 1913?
a panic and economic recession in 1907
what is a principal-agent view
a theory of central banking that holds that officials maximize their personal well-being rather than that of the general public
What is the aim of monetary policy?
advance the economic well-being of the country's citizens.
Why would the Fed slowing the rate at which it is purchasing these assets result in the growth of the monetary base slowing? When the Fed purchases these assets, it causes ________. This means that if the Fed stops buying these assets, the growth rate of the monetary base would slow.
bank reserves and currency in circulation to increase
Who are the Class A directors?
bankers
why was the federal reserve system split into 12 districts
because there was opposition in Congress to establishing a single, unified central bank.
An open market operation is when the Fed ________________. The Fed engages in open market operations in order to _____________
buy or sells securities in financial markets influence bank reserves and short-term interest rates
Why does Congress directly control fiscal policy—the federal government's decisions with respect to spending and taxes—but delegate the authority over monetary policy to the Federal Reserve?
congress wanted the federal reserve to operate independently of external political pressures
the federal reserve seeks to reduce
cyclical unemployment
As the federal funds rate decreases, the opportunity cost to banks of holding excess reserves _______________ because the return they could earn from lending out those reserves _______________
decrease; go down
It would be ________ for the Fed to have a set policy of deflating asset bubbles when it being so ______ to determine whether asset prices are inflated above their fundamental value or not
hard; hard
In an interview in July 2020, during the Covid-19 pandemic, Federal Reserve Bank of Dallas President Robert Kaplan stated: "I just don't want to pull out one objective . . . pulling out inflation . . . without regard to other considerations, and without regard to the second part of the dual mandate." What was Kaplan referring to as the "second part of the dual mandate"?
high employment
Which of the Fed's traditional monetary policy tools was the most important?
open market operations
what does seltzer mean by "potential monetary and credit expansion"?
referring to the multiple deposit creation process
Why would buying corporate bonds expose a central bank to more political pressure than would buying bonds issued by a government? Buying bonds in a particular industry ________ that industry and can lead to politicians ________.
supports; asking central banks to buy bonds in industries they support
Currency is a liability to the Fed rather than an asset, even though currency is considered vauable, because:
the Fed is responsible for maintaining the value of currency and a holder of currency could exchange it at the Fed.
The term "extraordinary easing measures" refers to
the Fed using all possible methods to engage in quantative easing.
How does the monetary base differ from the money supply? You must multiply the monetary base by _________________ to find the size of the money supply. For the Fed to be able to control the money supply by controlling the monetary base, ___________________
the money multiplier; the money multiplier must be stable
Evaluate the economist's statement. The economist is thinking that ________.
the president may want the Fed to lower interest rates during elections, but the Fed will focus on the long-term health of the economy.
What potential conflicts of interest is this document referring to? A Federal Reserve document states that: "due to concerns about potential conflicts of interest ... Class A directors may not participate in most aspects of the appointment process of Reserve Bank presidents and first vice presidents."
the supervision of member banks
The supply of reserves is determined by
the Fed's provision of non-borrowed reserves through open market operations. borrowed reserves in the form of discount loans from the Fed.
Why would these asset purchases cause the Fed's balance sheet to rise? The size of the Fed's balance sheet is usually based on the value of the Fed's
total assets
"Extraordinary easing measures" would end deflation by greatly ________ aggregate demand and thus pushing prices ____________
upward; increasing
In general, what do economists mean by a "principal-agent problem"? By a "principal-agent problem," economists mean ________.
when the goals and priorities of those in charge do not match the goals and priorities of the people they oversee
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.
Did the Fed's asset purchases also cause the monetary base to rise?
Yes, because the asset purchases would have increased reserves or currency in circulation.
