Monetary Policy

If banks kept no reserves at all, they would

probably fail since without any reserves they would not be able to cover any requests for withdrawals.

deposit insurance:

program which insures commercial bank depositors up to $250,000 per bank in the U.S.

Deposit insurance was created in the 1930s to

promote the credibility and safety of banks as a place to store one's money and therefore support the link between savers and borrowers

The banking sector is critical to the health of a market economy because it

provides the key connection between savers and borrowers that facilitates the flow of capital to to income and employment generating activities.

One mission of the Federal Reserve Bank can be aptly described as ________.

providing banking services to commercial banks

A contractionary or tight monetary policy

reduces borrowing

The proportion of deposits that banks are legally required to maintain either on hand or in their accounts with the central bank are called

reserve requirements

If the Fed increases the discount rate, then

reserves will decrease in the banking system

If the Federal Reserve bank raises reserve requirements, interest rates are likely to ________ and the supply of money will ________.

rise; decrease

If the Fed raises reserves requirements, then interest rates will ________ and the money supply will ________.

rise; fall

lender of last resort:

role of the Fed to provide loans to distressed banks when the banks can't obtain credit from anywhere else

An open market operation decreases the money supply when the Federal Reserve

sells bonds to banks, which decreases bank reserves.

If the Fed wants to decrease the quantity of money in the economy, it can

sells bonds.

Bank supervision consists mostly of

setting minimum reserve requirements, ensuring bank net worth remains positive, and setting restrictions on investments.

Quantitative easing undertaken after 2008 was deemed to be necessary because ________.

short-term interest rates had already been driven down to zero and could not go lower

quantitative easing (QE):

the purchase of long term government and private mortgage-backed securities by central banks to make credit available in hopes of stimulating aggregate demand

During the Great Recession, the direct targeting of long-term interest rates by the Federal Reserve Bank implies that private bank lending

was limited by overly restrictive credit requirements and was therefore suppressing economic activity

bank run:

when depositors fear their bank is insolvent, they will "run" to withdrawn their deposits; because of fractional reserve banking, bank runs can turn solvent banks insolvent

financial contagion:

when fears that one bank is insolvent spread to fears that other banks are insolvent; can cause bank runs to occur at multiple banks

illiquidity:

when the demand for cash by depositors exceeds the bank's available reserves

insolvency:

when the value of a bank's assets is less than the value of its liabilities; i.e. bankrupt

An increase in the Federal Funds rate implies that credit conditions are ________.

worsening

Consider the following balance sheet for Capital One. Assets Reserves 288 Loans 1512 Liabilities Deposits 1800 Suppose that someone deposited $300 at Capital One. Given this data, what is the maximum amount by which the money supply will increase?

1575

In the scenario where the Central Bank conducts an open market purchase of government securities, it is following what type of monetary policy?

An expansionary policy

Which of the following Federal Reserve bank actions would reduce the supply of money?

An open market sale of US Treasury securities

In an economy that is relatively unstable or more subject to negative influences out of its control (negative shocks) than other economies around the globe, how might the central bank set its reserve requirements relative to international averages?

They would be higher than the international average

Which of the following statements is correct?

Monetary policy has an indirect impact on aggregate demand

Suppose the Fed sells T-bills. As a result of this policy, what will happen to the money supply?

Money Supply decreases

Suppose the Fed decreases required reserve ratio. As a result of this policy, what will happen to the money supply?

Money Supply increases

expansionary (or loose) monetary policy:

a monetary policy that increases the supply of money and reduces interest rates

contractionary (or tight) monetary policy:

a monetary policy that reduces the supply of money and increases interest rates

If the Fed lowers the reserve requirement, then the results will be

an increase the availability of credit

A private bank that systematically engages in making risky loans to borrowers runs

an increased probability of facing a bank run by depositors.

Banks USA consistently makes risky loans to small businesses. When a recession hits, Banks USA faces

an increased probability of facing a bank run by depositors.

The independence in decision-making of the US Federal Reserve Bank's Board of Governors is critical since

otherwise they may be vulnerable to political pressures

If the Fed wishes to conduct expansionary monetary policy, it should

Decrease the discount rate

Consider the following statement and indicate if it is true, false or uncertain. "A sale of bonds held by a private bank to another private bank will have the exact same impact on the supply of money as a sale directly to the Federal Reserve Bank."

False

Which of the following statements is true?

Holding money when it could instead be in an interest bearing account is an opportunity cost to the holder.

Increasing the sophistication of the financial payments system benefits banks mostly because ________.

households will need to hold less of their wealth in the form of cash and will be able to leave more in the banks from where it can be loaned out for profit.

If the Fed ultimately wants to lower interest rates in the economy, then it should

lower the discount rate

If the Fed wants to increase the quantity of money in the economy, it can

lower the reserve requirement

Bank regulation requires that banks

maintain a minimum net worth in order to protect depositors and creditors.

federal funds rate:

the interest rate at which one bank lends funds to another bank overnight

prime rate:

the interest rate banks charge their very best corporate customers, borrowers with the strongest credit ratings

discount rate:

the interest rate charged by the central bank on the loans that it gives to other commercial banks

federal funds rate:

the interest rate on overnight, interbank loans.

capital market:

the markets for long term financial assets

money market:

the markets for short term financial assets

When the central bank decides it will buy bonds using open market operations

the money supply increases

reserve requirement:

the percentage amount of its total deposits that a bank is legally obligated to to either hold as cash in their vault or deposit with the central bank

Assume that the banking system has total reserves of $520 billion. Assume also that required reserves are 26 percent and that banks do not hold any excess reserves and households hold no currency. Now suppose that the Fed increased the required reserves to 31.2. As a result of this new policy, by how much has the money supply changed?

-333.33

Assume that the banking system has total reserves of $368 billion. Assume also that required reserves are 16 percent and that banks do not hold any excess reserves and households hold no currency. Now suppose that the Fed increased the required reserves to 19.2. What is the level of excess reserves? Make sure to include a negative sign if necessary.

-73.6

Which of the following scenarios may compel the Federal Reserve bank to reduce its discount rate? [Hint: it's more than one.]

1. Falling demand in the federal funds market has driven interest rates in that market below the discount rate. 2. Over-leveraged banks experience a run on deposits and are unable to cover it without sufficient ability to borrow directly from the Fed.

Suppose that the required reserve ratio (R) is 13 percent and that banks do not hold any excess reserves. What is money multiplier, given this situation?

1/.13 = 7.69

How many regional Federal Reserve banks are there in the U.S. who primarily support banks and the economy within their respective districts?

12

The Federal Reserve includes:

12 Regional Federal Reserve Districts A Board of Governors The Federal Open Market Committee

Assume that the banking system has total reserves of $168 billion. Assume also that required reserves are 7 percent and that banks do not hold any excess reserves and households hold no currency. Now suppose that the Fed decreased the required reserves to 5.6. What is the new multiplier?

17.86

Suppose that the Fed sell $440 million of government bonds. In addition, suppose that the required reserve ratio (R) is 49 percent and that banks do not hold any excess reserves. What is money multiplier?

2.04

Assume that the banking system has total reserves of $420 billion. Assume also that required reserves are 35 percent and that banks do not hold any excess reserves and households hold no currency. Now suppose that the Fed increased the required reserves to 42. What is the new multiplier?

2.38

Assume that the banking system has total reserves of $480 billion. Assume also that required reserves are 24 percent and that banks do not hold any excess reserves and households hold no currency. What is the size of the M1 money supply?

2000

Assume that the banking system has total reserves of $1296 billion. Assume also that required reserves are 48 percent and that banks do not hold any excess reserves and households hold no currency. Now suppose that the Fed decreases the required reserves to 38.4. What is the level of excess reserves? Make sure to include a negative sign if necessary.

259.2

Assume that the banking system has total reserves of $588 billion. Assume also that required reserves are 21 percent and that banks do not hold any excess reserves and households hold no currency. What is the level of deposits?

2800

Assume that the banking system has total reserves of $990 billion. Assume also that required reserves are 33 percent and that banks do not hold any excess reserves and households hold no currency. What is money multiplier?

3.03

Suppose that the Fed conducts a $190 million open market purchase of government bonds. In addition, suppose that the required reserve ratio is 39 percent and that banks do not hold any excess reserves. What is the effect on the money supply? More precisely, by how much will the money supply increase?

487.17

Assume that the banking system has total reserves of $391 billion. Assume also that required reserves are 17 percent and that banks do not hold any excess reserves and households hold no currency. What is the money multiplier?

5.88

Assume that the banking system has total reserves of $400 billion. Assume also that required reserves are 16 percent and that banks do not hold any excess reserves and households hold no currency. Now suppose that the Fed decreased the required reserves to 12.8. As a result of this new policy, by how much has the money supply increased?

625

Suppose that the Fed sells $120 million of government bonds. In addition, suppose that the required reserve ratio is 19 percent and that banks do not hold any excess reserves. What is the effect on the money supply? More precisely, by how much will the money supply change?

631.58

If you were a bank regulator which of the following banks you reviewed would cause concern and warrant a deeper evaluation?

A bank that holds the minimum amount of assets in reserves, holds the vast majority of its total assets in form of loans to just one particular industry and another small share of its assets held in the form of mortgages to domestic home purchasers.

Suppose the Fed sells T-bills. As a result of this policy, what will happen to the Aggregate Demand (AD)?

AD will shift to the left

Suppose the Fed buys T-bills. As a result of this policy, what will happen to the Aggregate Demand (AD)?

AD will shift to the right

Suppose interest rates increase. As a result of this, what will happen to consumption (C) and investment (I)?

Both C and I will decrease

Suppose interest rates decrease. As a result of this, what will happen to consumption (C) and investment (I)?

Both C and I will increase

Suppose the Fed increase discount rate. As a result of this policy, what will happen to price level and GDP in the short run?

Both price level and GDP will decrease.

Suppose the Fed decreases discount rate. As a result of this policy, what will happen to price level and GDP in the short-run?

Both price level and GDP will increase.

If the Fed wishes to conduct expansionary monetary policy, it should

Buy T-bills

What tool might the Fed use to boost the economy during a recession?

Buying U.S. Treasury securities

If the Fed wishes to conduct contractionary monetary policy, it should

Increase the discount rate

Suppose the Fed decreases required reserve ratio. As a result of this policy, what will happen to the interest rates?

Interest rate will decrease

Suppose the Fed increases discount rate. As a result of this policy, what will happen to the interest rates?

Interest rate will increase

Which of the following statements about TARP is correct?

TARP encourages risky behavior on the part of large banks and other large corporate entities that the FED had saved from bankruptcy.

If the Fed wishes to conduct contractionary monetary policy, it should

Sell T-bills

Why are banks susceptible to potential bank runs?

Since banks keep only a fraction of their deposits on hand as reserves, a much higher customer customer demand to withdraw funds in a short period time may be impossible to manage.

Which of the following statements is true?

The Federal Reserve Bank has indirect and imperfect control over interest rates.

What would economic conditions potentially be like in the U.S if the Federal Reserve did not regulate monetary policy, monitor banks, and provide services for banks?

The economy would be less efficient and transactions would most likely be more costly.

Which of the following statements is correct?.

The episodes of major Federal Reserve Bank actions during the past 40 years suggest that improved accuracy of projected inflation or unemployment would help the FED to avoid recessions or periods of high inflation entirely.

What is the reasoning behind having the seven Fed Board of Governors remain for 14 years on the Federal Reserve?

The longer terms are to insulate the members from immediate political pressures and have them focus solely on economic solutions for the nation.

Suppose the public suddenly decides that private sector banks are too risky to trust its money with. How might this be represented on the diagram of Figure 1 and what happens to private investment as a result?

The money demand curve shifts to the right. The money supply curve remains in place but interest rates rise along it, reducing private investment.

Suppose the Federal Reserve Bank increases the reserve ratio. Which of the following would be the best representation of this policy on the money market equilibrium in Figure 1 above?

The money supply curve shifts to the left and money demand falls along the investment demand curve.

In Figure 1, the supply curve for loanable funds slopes upward in interest rates. How would the supply curve appear if savings were fixed instead of being a function of interest rates, and how would this impact interest rates relative to an upwards sloping supply curve if the investment demand function shifted its position?

The money supply curve would be vertical.

What happens to the money supply if the Fed lowers the discount rate?

The money supply increases

Which of the following statement is likely to be true?

The purchase of bonds by the Federal Reserve Bank is an expansionary monetary policy in part because the Federal Reserve Bank is a large player in the bond market and can influence bond prices.

How do central bank policies affect interest rates?

When the central bank decides to increase the discount rate, then other interest rates increase.

bank capital requirements minimum percentage (of assets):

a bank's capital must exceed to stay in operation

market for loanable funds

a broad view of financial markets, including equities, bonds, bank accounts, credit, and all other financial assets

In an economy where the money supply and aggregate demand have been decreased by the Central Bank, you know that the Central Bank is using

a contractionary monetary policy

Financial contagion may result in lost integrity in the entire financial system. To prevent this from happening, the Fed may

act as the lender of last resort to make short-term emergency loans to member banks, as needed

If the Federal Reserve Bank did not exist, economic transactions would ________.

be less efficient and more costly

The Fed is more likely to raise the discount rate when the economy is ________.

booming

The banking system enhances the workings of the economy because without a banking system,

businesses would find it more difficult to acquire the financial resources necessary to purchase economic capital

During the latter half of the 20th century, the Federal Reserve typically reacted to higher inflation with a/an

contractionary monetary policy and a higher interest rate.

Which of the following actions by the Fed will increase the money supply?

decreasing the reserve requirement or buying Treasury bonds.

The interest rate charged by the central bank when it makes loans to commercial banks is called the

discount rate

An open market purchase of U.S. Treasury bonds by the central bank will ________ credit conditions for private firms.

ease

Which of the following is NOT an important role of the Federal Reserve Bank?

generating profits

A bank holding just over the minimum level of cash reserves with a high volume of loans made to developing countries and a large share of assets in the form of loans to more stable domestic industries and households should receive________.

increased scrutiny by bank regulators.

Monetary policy should be conducted mindful of the tradeoff between ________.

inflation and unemployment

central bank:

institution which conducts a nation's monetary policy and regulates its banking system

Changing reserve requirements is relatively rare because

it can be extremely costly to private sector banks

While the role of "lender of last resort" supports banking system credibility, the problem with such a commitment is that

it encourages excessive risk taking by bank managers in their choice of loans.

If the Federal Reserve Bank decides to reduce the discount rate it is likely that

it is pursuing a pro-growth policy

The Fed's efforts to manage interest rates and thus the availability of credit is known as

monetary policy

countercyclical:

moving in the opposite direction of the business cycle of economic downturns and upswings

The Federal Reserve Chairperson is tasked with providing the US Congress with regular policy updates. It is known that such testimony can move global equity and bond markets up or down primarily because ________.

the U.S. economy is so large and its current so prevalent on the global market that the effects of Fed policy will impact wealth and income around the globe

open market purchase:

the central bank buys Treasure securities to increase bank reserves and lower interest rates

Federal Reserve:

the central bank of the United States run by a 7-member Board of Governors in conjunction with 12 regional Federal Reserve banks

open market operations:

the central bank selling or buying Treasury bonds to influence the quantity of money and the level of interest rates

open market sale:

the central bank sells Treasure securities to decrease bank reserves and raise interest rates

Ultimately, the Federal Reserve ensures that ________.

there will always be sufficient loanable funds for investors to tap for economic growth generating activities

Which of the following is NOT a risk of quantitative easing?

unemployment