econ test 4
Which of the following best describes the cause-effect chain of a restrictive monetary policy?
A decrease in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand and GDP.
An asset's liquidity refers to its ability to be:
A means of payment
Assuming government wishes to either increase or decrease the level of aggregate demand, which of the following pairs are not consistent policy measures?
A tax increase and an increase in the money supply.
Which of the following statements regarding Monetarists is true?
All of the above.
Members of the Federal Reserve Board of Governors are:
Appointed by the President to staggered 14-year terms
If you write a check on a bank to purchase a used Honda Civic, you are using money primarily as:
a medium of exchange.
All of the following are functions of the Federal Reserve District Banks except:
accepting deposits from individuals.
During periods of hyper-inflation, money may cease to work as a medium of exchange:
because people and businesses will not want to accept it in transactions.
Currency in circulation is part of:
both M1 and M2.
If the economy were encountering a severe recession, proper monetary and fiscal policies would call for:
buying government securities, reducing the reserve ratio, reducing the discount rate, reducing interest paid on reserves held at Fed banks, and a budgetary deficit.
One of the strengths of monetary policy relative to fiscal policy is that monetary policy:
can be implemented more quickly.
The interest rate that banks charge one another on overnight loans is called the:
federal funds rate.
The "coincidence of wants" problem associated with barter refers to the fact that:
for exchange to occur, each seller must have a product that some buyer wants.
The Federal Reserve System performs many functions but its most important one is:
Controlling the money supply
The Federal backing for money in the United States comes from:
Controlling the money supply in order to keep the value of money relatively stable over time
Refer to the given market-for-money diagrams. The asset demand for money is shown by:
D2.
The financial crisis hastened the ongoing process in which the financial services industry was transforming from having a few large firms to many small firms.
False: The financial crisis in fact hastened just the opposite, a movement of consolidation from many small firms to fewer large firms.
Paper money (currency) in the United States is issued by the:
Federal Reserve Banks.
To say that the Federal Reserve Banks are quasi-public banks means that:
they are privately owned but managed in the public interest.
Money market deposit accounts are included in:
M2 only.
Suppose that the Fed has set the reserve ratio at 10 percent and that banks collectively have $2 billion in excess reserves. What is the maximum amount of new checkable-deposit money that can be created by the banking system through lending?
$20 billion: The correct answer is that the banking system can create a maximum of $20 billion in new checkable-deposit money. To see why this is true, begin with the fact that the monetary multiplier m is the reciprocal of the reserve ratio. That is, m = (1/R). Given that the Fed in this problem has set the reserve ratio at 10 percent, this formula implies that the monetary multiplier will be equal to 10 (= 1/0.10). Next, remember that the banking system's maximum checkable-deposit money creation D is equal to the banking system's excess reserves E times the monetary multiplier, or D = E × m. Given that we know that the excess reserves are $2 billion and m = 10, this formula implies that the maximum checkable-deposit money creation will be D = $20 billion (= $2 billion in excess reserves × monetary multiplier of 10).The initial $2 billion in excess reserves can be multiplied into up to $20 billion in new checkable-deposit money because when bank A extends a loan and creates new money, that money will eventually be deposited in another bank B, where any part of that amount except the required reserve amount can be lent out again. With this process repeating itself from bank B to bank C to bank D, a single dollar in initial excess reserves at bank A can initiate a much larger total volume of loans.
The Federal Reserve System is divided into: Multiple Choice
12 districts
Answer the question on the basis of the following list of assets:1. Large-denominated ($100,000 and over) time deposits2. Noncheckable savings deposits3. Currency (coins and paper money) in circulation4. Small-denominated (under $100,000) time deposits5. Stock certificates6. Checkable deposits7. Money market deposit accounts8. Money market mutual fund balances held by individuals9. Money market mutual fund balances held by businesses10. Currency held in bank vaultsRefer to the given list. The M1 definition of money comprises item(s):
3 and 6.
How many members can serve on the Board of Governors of the Federal Reserve System?
7
A bond with no expiration date has a face value of $11,000 and pays a fixed annual interest payment of $1,000. The bond's annual interest yield approximately equals:
9 percent
Which of the following Fed actions will increase bank lending and, thus, increase the money supply?
Bank lending will rise when the Fed buys $400 million worth of Treasury bonds from commercial banks and when the Fed lowers the discount rate from 4 percent to 2 percent. If the Fed buys $400 million worth of Treasury bonds from commercial banks, the Fed will create $400 million worth of new money to pay for the bonds. That money will flow to the banks that sold the bonds to the Fed, thereby increasing their reserves. Because reserves only generate profits if they are lent out, these higher reserves will tend to increase bank lending. If the Fed lowers the discount rate from 4 percent to 2 percent, more banks will borrow money from the Fed, thereby increasing their reserves. Because reserves only generate profits if they are lent out, these higher reserves will tend to increase bank lending.By contrast, the two other answers are incorrect because they will cause bank reserves to contract. For example, if the Fed raises the discount rate from 5 percent to 6 percent, banks will borrow less money from the Fed, thereby reducing reserves relative to what they were when banks were borrowing more at the lower 5 percent interest rate. With less reserves, banks will reduce their lending. Finally, if the Fed raises the reserve ratio from 10 percent to 11 percent, it will increase the fraction of bank reserves that they must keep on hand, unloaned. Thus raising the reserve ratio directly reduces the lending capacity of banks as they can now only lend a smaller fraction of their reserves.
When the Fed acts as a "lender of last resort", like it did in the financial crisis of 2007-2008, it is performing its role of:
Being the bankers' bank
Michelle transfers $4,000 from her savings account to her checking account. What effect is this change likely to have on M1 and M2?
M1 increases, M2 stays the same, and the system becomes more liquid
The most important among the Federal Reserve district banks in conducting monetary policy is the:
New York bank
Which of the following tools of monetary policy is considered the most important on a day-to-day basis?
Open-market operations.
The reason for the Fed being set up as an independent agency of government is to:
Protect it from political pressure
Refer to the given market-for-money diagrams. If the Federal Reserve increased the stock of money, the:
S curve would shift rightward and the equilibrium interest rate would fall.
James borrows $300,000 for a home from Bank A. Bank A resells the right to collect on that loan to Bank B. Bank B securitizes that loan with hundreds of others and sells the resulting security to a state pension plan, which at the same time purchases an insurance policy from AIG that will pay off if James and the other people whose mortgages are in the security can't pay off their mortgage loans. Suppose that James and all the other people can't pay off their mortgages. Which financial entity is legally obligated to suffer the loss?
AIG: Because it sold loan-default insurance to the pension plan, AIG will have to suffer the loss when James and the other mortgage borrowers can't pay off their mortgages. During the financial crisis, the insurance company AIG was overwhelmed with claims on the many "collateralized default swaps" that it had sold as insurance on mortgage securities. When the housing bubble burst and millions of mortgages went into default simultaneously, AIG didn't have enough money to pay off on all of the mortgage insurance policies that it had sold. This caused chaos in the financial markets because if AIG couldn't pay off on its insurance obligations, then the financial firms that had bought insurance from it were going to have to suffer the losses. But they had not bothered to set aside any money to cover losses because they thought that they didn't have to worry about losses because they had bought insurance from AIG. As a result, those financial firms were themselves about to go bankrupt because AIG couldn't pay off on the insurance policies that it had sold. The financial world was thus looking like a bunch of dominos ready to knock each other over one by one. If AIG failed, those who had bought insurance from it would fail. And if they failed, they would knock over other firms to whom they in turn owed money, and so on. To stop that whole process from happening, the government bailed out AIG so that it could pay out on its insurance obligations.
Which of the following best describes the cause-effect chain of an expansionary monetary policy?
An increase in the money supply will lower the interest rate, increase investment spending, and increase aggregate demand and GDP.
Which of the following would be considered to be the most liquid?
Checkable deposits
The use of money for exchange and trade:
Fosters more specialization in production
The government bail-out of large institutions creates the problem of moral hazard, which means that these large firms will:
Have an incentive to make highly risky investments
If the Federal Reserve wants to increase the federal funds rate using open-market operations, it should _____________ bonds.
If the Fed wants to increase the federal funds rate using open-market operations, it should sell bonds. This is true because those who purchase bonds from the Fed will have to pay for them with money. Thus, when the Fed sells bonds, money flows from the outside economy back into the Fed. That implies that less money is sitting in the banking system. As a result, some bank or others will see its level of reserves fall. With fewer reserves thus held in the banking system as a whole, there will a smaller supply of federal funds in the federal funds market. Assuming a constant demand for federal funds, that smaller supply will lead to a higher equilibrium federal funds interest rate in the federal funds lending market. Thus, when the Fed sells bonds, it raises the federal funds rate.
Which of the following statements is correct?
Interest rates and bond prices vary inversely.
Answer the question on the basis of the following list of assets:1. Large-denominated ($100,000 and over) time deposits2. Noncheckable savings deposits3. Currency (coins and paper money) in circulation4. Small-denominated (under $100,000) time deposits5. Stock certificates6. Checkable deposits7. Money market deposit accounts8. Money market mutual fund balances held by individuals9. Money market mutual fund balances held by businesses10. Currency held in bank vaultsRefer to the given list. The M2 definition of money comprises:
Items 2, 3, 4, 6, 7, and 8.
Assume that the following asset values (in millions of dollars) exist in Ironmania:A)M1 B)M2 Federal Reserve Notes in circulation$800 Money market mutual funds (MMMFs) 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$1,500 Small-denominated (less than $100,000) time deposits$100 Coins in circulation$40
M1 equals Federal Reserve Notes in circulation plus checkable deposits plus coins in circulation: M1 = $750 + $1,600 + $40 = $2,390 million.M2 equals M1 plus savings deposits including money market deposit accounts (MMDAs) plus small-denominated (less than $100,000) time deposits plus money market mutual funds (MMMFs) held by individuals: M2 = $2,390 + $140 + $100 + $400 = $3,030 million.
What does it mean when economists say that the Federal Reserve Banks are central banks, quasi-public banks, and bankers' banks? Explain the meaning of each term. **You must write a minimum of 60 words to receive full credit.
The Federal Reserve Banks are central banks, meaning that they are the monetary authority that controls the money supply for our country. They are quasi-public banks, meaning that they blend private ownership and public control. Each Federal Reserve Bank is privately owned by the private commercial banks in its district. All Federal Reserve Banks' monetary policies are coordinated by the Board of Governors. They are also bankers' banks, meaning that they perform essentially the same services and functions for commercial banks as those institutions perform for the public.
A decrease in the supply of Federal funds is shown as an upshift of the supply curve above because the interest rate
The decrease in the supply of Federal funds is shown as an upshift in the supply curve because the FED will ensure that the quantity of funds supplied equals the quantity of funds demanded at the targeted rate of 4.5%. In effect, the FED creates a perfectly elastic (horizontal) supply curve to target the rate of 4.5%.This logic applies to an increase in Federal funds where we observe a downshift in the supply curve. Here the FED targets the rate of 3.5%, so the amount of funds in the market are constantly adjusted to match demand at this targeted rate. Again, in effect the supply curve is perfectly elastic(horizontal).
Suppose that Serendipity Bank has excess reserves of $14,000 and checkable deposits of $150,000.If the reserve ratio is 20 percent, what is the size of the bank's actual reserves?
The first step is to calculate the required reserves for the bank. This equals the product of the required reserve ratio (decimal form) and checkable deposits. Required reserves = 0.20 × $150,000 = $30,000. The second step is to calculate actual reserves. This is the sum of required reserves and excess reserves. Actual reserves = required reserves + excess reserves = $30,000 + $14,000 = $44,000.
Which of the following will increase the lending of commercial banks and, thus, increase the money supply?
The purchase of government bonds in the open market by the Federal Reserve Banks.
Which of the following will decrease the lending of commercial banks and, thus, decrease the money supply?
The sale of government bonds in the open market by the Federal Reserve Banks.
The two conflicting goals facing commercial banks are:
The two conflicting goals facing commercial banks are profit and liquidity. On the one hand, commercial banks want to make profits. On the other hand, they need liquidity so that at least some of the assets that they own can be quickly liquefied and sold for cash if an unexpectedly large number of depositors suddenly want their money back. This causes a conflict for bank managers because assets and investments that offer higher rates of return are typically not very liquid. Thus, banks must compromise between earning higher profits and remaining suitably liquid in their asset holdings.
A commercial bank has $100 million in checkable-deposit liabilities and $12 million in actual reserves. The required reserve ratio is 10 percent. How big are the bank's excess reserves?
This bank has $2 million of excess reserves. The bank's excess reserves can be calculated by subtracting the bank's required reserves from the bank's actual reserves of $12 million. The bank's required reserves are $10 million (= reserve ratio of 10 percent (0.10) × $100 million in checkable-deposit liabilities). Thus, the bank's excess reserves are equal to $2 million (= $12 million in actual reserves - $10 million in required reserves).
Suppose a bond with no expiration date has a face value of $10,000 and annually pays a fixed amount of interest of $700. a. In the table provided below, calculate and enter either the interest rate that the bond would yield to a bond buyer at each of the bond prices listed below or the bond price at each of the interest yields shown. b. What generalization can be drawn from the completed table?
a. To answer this question, we use the formula for a perpetuity. Bond price = fixed payment amount/interest yield, or interest yield = fixed payment amount/bond price. Bond price $8,000: Interest yield = $700/$8,000 = 0.0875, or 8.75 percent. Interest yield 7.78 percent: Bond price = $700/0.0.0778 = $9,000 (rounded to the nearest hundred dollars). Bond price $10,000: Interest yield = $700/$10,000 = 0.07, or 7 percent. Bond price $11,000: Interest yield = $700/$11,000 = 0.0636, or 6.36 percent. Interest yield 5.38 percent: Bond price = $700/0.0538 = $13,000 (rounded to the nearest hundred dollars). b. The generalization is that bond prices and interest rates are inversely related.
For an item to act as a medium of exchange and a store of value, it must be which of the following:
all of the above.
Refer to the diagram for the federal funds market. If the Fed wants to raise the federal funds rate from if1 to if3, it can use open-market operations to:
decrease the supply of federal funds by selling bonds.
It is costly to hold money because:
in doing so, one sacrifices interest income.
Interest paid on reserves held at the Fed:
incentivizes financial institutions to hold more reserves and reduce risky lending.
Answer the question on the basis of the following consolidated balance sheet of the commercial banking system. Assume that the reserve requirement is 10 percent. All figures are in billions and each question should be answered independently of changes specified in any preceding ones.Refer to the given data. Suppose the Fed bought $20 billion of U.S. securities from the banks. This would:
increase bank reserves to $80 billion, reduce bank-held securities to $120 billion, and, assuming a full money multiplier effect, increase the money supply (checkable deposits) by $200 billion.
Refer to the diagrams. The numbers in parentheses after the AD1, AD2, and AD3 labels indicate the levels of investment spending associated with each curve. All figures are in billions. If aggregate demand is AD1 and the monetary authorities desire to increase it to AD2, they should:
increase the money supply from $80 to $100.
Refer to the diagram for the federal funds market. If the Fed wants to lower the federal funds rate from if1 to if2, it can use open-market operations to
increase the supply of federal funds by buying bonds.
The various lender-of-last-resort programs implemented by the Fed in response to the financial crisis of 2007 and 2008:
increased the moral hazard problem by limiting losses from bad financial decisions.
A decrease in the legal reserve ratio:
increases the money supply by increasing excess reserves and increasing the monetary multiplier.
Monetary policy may be ineffective if:
investment and consumer spending are not sensitive to changes in short-term interest rates.
The transactions demand for money is most closely related to money functioning as a:
medium of exchange.
City Bank is considering making a $50 million loan to a company named SheetOil that wants to commercialize a process for turning used blankets, pillowcases, and sheets into oil. This company's chances for success are dubious, but City Bank makes the loan anyway because it believes that the government will bail it out if SheetOil goes bankrupt and cannot repay the loan. City Bank's decision to make the loan has been affected by:
moral hazard: As it relates to financial investment, moral hazard is the tendency for financial investors to take on greater risks because they are at least partially insured against losses. In this case, City Bank is only willing to invest because it believes that it will be bailed out by the government if SheetOil cannot repay the loan. Moral hazard is a large problem for the government because every time it intervenes to save a financial institution, it leads all the remaining financial institutions to believe that they, too, will probably be bailed out if they at any point in the future get into financial trouble. Once they believe that to be the case, they are much more likely to make risky loans. Why? Because risky loans have very high payouts when things go well. Thus, if things go well, the bankers get very rich. And if things go badly, it's not their problem because the government will bail them out.
An increase in nominal GDP increases the demand for money because:
more money is needed to finance a larger volume of transactions.
Banks lost money during the mortgage default crisis because:
of all of these reasons.
The discount rate is the interest:
rate at which the Federal Reserve Banks lend to commercial banks.
Answer the question on the basis of the following consolidated balance sheet of the commercial banking system. Assume that the reserve requirement is 10 percent. All figures are in billions and each question should be answered independently of changes specified in any preceding ones.Refer to the given data. Suppose the Fed sold $10 billion of U.S. securities to the banks. This would:
reduce bank reserves to $50 billion, increase bank-held securities to $150 billion, and ultimately decrease the money supply (checkable deposits) by $100 billion.
If the legal reserve ratio falls from 25 percent to 10 percent, excess reserves of this single bank will:
rise by $6,000 and the monetary multiplier will increase from 4 to 10.
If the economy were encountering severe demand-pull inflation, proper monetary and fiscal policies would call for:
selling government securities, raising the reserve ratio, raising the discount rate, increasing interest paid on reserves held at Fed banks, and a budgetary surplus.
If you place a part of your summer earnings in a savings account, you are using money primarily as a:
store of value.
The asset demand for money is most closely related to money functioning as a:
store of value.
The liquidity trap refers to the situation where:
the Fed adds excess reserves to the banking system, but it has minimal positive effect on lending, investment, or aggregate demand.
The four main tools of monetary policy are:
the discount rate, the reserve ratio, interest on reserves, and open-market operations.
The voting members of the Federal Open Market Committee (FOMC) include:
the seven members of the Board of Governors, the President of the New York Federal Reserve District Bank, and four Federal Reserve District Bank Presidents on a rotating basis.
Refer to the given market-for-money diagrams. Curve D1 represents the:
transactions demand for money.
A $70 price tag on a sweater in a department store window is an example of money functioning as a:
unit of account.
Money is more efficient than barter for conducting transactions because:
using money does not require satisfying a double coincidence of wants, which reduces transaction times.
