Money and banking test #3 top hat

equation of exchange

% change money growth + % change velocity = % change of inflation + % change of real growth

What is the intercept?

.02514

Suppose you run a regression of the annual change in GDP price level on the annual percent change in M2 money stock, and you obtain the following results (below). What is the beta coefficient?

.1159

If money velocity increases by 10% over the past year, what do we expect the percentage change in the price level to be over the same period (using the regression output below)?

3.67 = .11597 * .10 + .02514 price change = % change M * % change v + intercept

Why are the zero and nominal lower bounds not the same?

????????

2007 US housing bubble bursts

A boom in U.S. housing prices abruptly reverses course in 2006. Declines accelerate in 2007, which will see the largest single-year drop in U.S. home sales in more than two decades. The downturn prompts a collapse of the U.S. subprime mortgage industry, which offered loans to individuals with poor credit, sometimes without requiring a down payment. More than twenty-five subprime lending firms declare bankruptcy in February and March 2007. The collapse rattles the Dow Jones Industrial Average, which measures the combined stock values of the thirty largest companies in the United States. On February 27, it loses 416 points, its biggest one-day point loss since 9/11.

What is a mortgage-backed security? A collateralized debt obligation? A credit default swap? What role did they play in the crisis?

A derivative security composed of a residential or commercial real estate mortgage. A collateralized debt obligation (CDO) is a portfolio of debt instruments of varying credit qualities created and packaged for resale as an asset-backed security. The collateral in the CDO is the real estate, aircraft, heavy equipment, or other property the loan was used to purchase. A credit default swap (CDS) is a derivative contract that derives its value from the credit quality and performance of any specified asset. The CDS was invented by a team at JPMorgan in 1997, and was designed to shift the risk of default to a third party. It is a way to bet on whether a specific mortgage or security will either fail to pay on time, or fail to pay at all.

For which of the following would the fed raise interest rates without hesitation?

A shift in aggregate demand above potential output

What is AIG and what role did AIG play in the crisis?

AIG's swaps on subprime mortgages pushed the otherwise profitable company to the brink of bankruptcy. As the mortgages tied to the swaps defaulted, AIG was forced to raise millions in capital. As stockholders got wind of the situation, they sold their shares, making it even more difficult for AIG to cover the swaps. AIG faced distress because of its exposure from selling credit default swaps. Fed was terrified from the scenario that AIG wouldn't meet its margin calls and the contagion effect to AIG counterparties. Thus, Fed decided to bailout AIG. The difference between AIG and Lehman was, according to Fed, that AIG's problem was liquidity while Lehman was insolvent and based on the legislation it couldn't be bailed out.

2009 obamas early moves

Amid a wave of global spending on fiscal stimulus, newly inaugurated President Barack Obama signs a $787 billion stimulus package into law. It wins praise from some economists, who laud Obama's recognition of the urgency of the moment, but others criticize the bill for raising the debt or focusing on wasteful projects. Meanwhile, Treasury Secretary Timothy Geithner unveils his financial rescue plan, which includes so-called stress testing for big banks. It also aims to use Federal Reserve lending facilities to free up credit for consumers and small businesses and create a public-private partnership to take troubled assets off of businesses' balance sheets.

The Taylor rule is

An approximation that seeks to explain how the FOMC sets their target = natural rate + current inflation + 1/2 (difference in gdp rate) + 1/2(difference in inflation rate)

2013 regulators approve volcker rule

Authorized by the Dodd-Frank legislation, regulators finalize the so-called Volcker Rule, originally proposed by former Fed Chairman Paul Volcker. The heart of the rule is to reduce systemic risk in the U.S. financial system by prohibiting commercial banks from proprietary trading, or using their customers' deposit funds to make risky bets in the market. The rule draws criticism from the banking industry, which argues it is too complicated and costly to comply with.

2008 fire sale of bear stearns

Bear Stearns announces major liquidity problems and is granted a twenty-eight-day emergency loan from the New York Federal Reserve Bank. Investors are fearful that the firm's demise could spark a collapse of the financial sector. Two days later, JPMorgan Chase buys Bear Stearns for $2 per share in a rescue deal backed by $30 billion in Fed financing. (Later, it will increase its bid to $10 per share.) The bank traded at a high of $172 per share only weeks earlier. The sudden collapse and fire sale of one of the most iconic institutions on Wall Street spark broad fears about the stability of the financial sector.

Why might controlling inflation in the short run differ than the long run?

Because velocity is constant in the long run, but not in the short run

Raising interest rates following the use of unconventional policy tools depends on

Both the size and composition of the central bank's balance sheet

What is a forward guidance?

Communication about the likely future course of monetary policy

1992 new rules for fannie and freddie

Congress passes legislation that requires government-sponsored mortgage giants Fannie Mae and Freddie Mac to devote a percentage of their lending to affordable housing. This leads to an increase in the overall number of loans being pooled and securitized or sold as financial instruments to other investors. Two years later, J.P. Morgan introduces the first credit default swap (CDS), a credit derivative that can act as a kind of insurance against defaults for investors. Over the next decade and a half, CDSes become the most widely traded credit derivative product globally. The CDS market proves to be a major source of systemic risk to the U.S. financial system when the crisis hits more than a decade later.

While GDP was once a key cyclical indicator, its usefulness has declined substantially for all of the following reasons except which one?

Contains too much information

Why did conventional monetary policy not work during the financial crisis?

Conventional Monetary Policy , central banks supplies ➙ fall in inter-bank rate - banks reduce market rate which stimulates economic activity and inflation. •Zero Lower bound: when inter-bank hits 0 cant go lower. •Liquidity trap - adding base money no longer reduced inter-bank rate. •Monetary impotence - conventional monetary policy, no longer efffective

For which countries can changes in money velocity largely be ignored for controlling inflation via the money supply in the short run?

Countries with high inflation

History shows that

Countries with high rates of money growth have high rates of inflation

In the equation: MV = PY, what is used for P?

GDP deflator level

1995 subprime market grows

In 1995, changes to the Community Reinvestment Act, originally passed to end discrimination against low-income borrowers, allow mortgage lenders to buy "subprime" securities to fulfill their affordable-housing lending obligations. Some economists argue that the resulting higher demand for subprimes encourages the proliferation of risky housing loans during the latter half of the 1990s. In September 1999, Fannie Mae eases credit requirements to encourage banks to extend loans to people whose credit is lower than what is required for conventional loans, furthering growth in the subprime lending industry.

2007 subprime bankruptcies proliferate

In April 2007, New Century Financial Corporation, the largest U.S. subprime lender, files for bankruptcy as analysts worry about the impact subprime mortgages will have on the broader financial sector, which invested heavily in securitized debt from subprime loans. In July, Bear Stearns, one of the largest U.S. investment banks, announces two of its hedge funds have lost almost all of their investor capital and will file for bankruptcy. It is one of the first signs of major problems in financial markets beyond the subprime loan industry.

2004 wall street places riskier bets

In April, the Securities and Exchange Commission (SEC) loosens the net capital rule, which had limited broker-dealers and investment banks to a 12-to-1 leverage (the ratio of debt to equity) on investments. The change allows firms with more than $5 billion in assets to leverage themselves an unlimited number of times. Qualifying firms at the time include Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs, and Morgan Stanley. These firms greatly increase the amount of leverage they employ to a point where they routinely use thirty times leverage on investments. None of the five firms survive the 2008 credit crisis intact as independent investment banks.

1999 glass-stegall weakened

In November, President Bill Clinton signs off on a law that partially repeals the Glass-Steagall Act of 1933, which had prevented banks from operating other financial businesses, such as insurance and investment brokerages. One year later, new rules exempt credit default swaps and trading on electronic energy commodity markets from regulation.

2007 fed slashes rates and market peaks

In September, the Federal Reserve makes its first in a series of interest rate cuts, lowering the benchmark federal funds rate for the first time since 2003, from 5.25 percent to 4.75 percent. By December 2008, the Fed will cut rates to between 0 percent and 0.25 percent. During this period, the Dow Jones Industrial Average peaks at more than 14,000 points. By February 2009, the Dow plummets by more than 50 percent, to just over 6,500.

All other factors equal, as nominal interest rates increase, checking account balances should

Increase

As a person's wealth increases, we would expect the demand for money to

Increase but a rate less than dollar for dollar

Target federal funds rate = natural rate of interest + current inflation + 1/2 (inflation gap) + 1/2 (output gap) to determine the change in the target federal funds rate for every one percent increase in the rate of inflation. This will

Increase the target funds rate by 1.5 percent and increase the real federal funds rate by .5 percent

The primary monetary policy tool most used by central banks today is

Interest rates

A major contributing factor to the instability of money demand over the past 25 years is the

Introduction of financial instruments that that pay higher returns than money but can be used as a means of payment

Why did velocity of M2 fall during the financial crisis?

Investors demand for holding money went way up

Which one of the following statements is most correct?

It is impossible to have high, sustained inflation without monetary accommodation

What is the global savings glut and how did that affect the financial crisis?

It is when global investors poured money into the US because people wanted to save more than spend. It happened before the crisis, and it brought down interest rates which caused people to look for higher yields and led them to mortgage backed securities.

What role did the saving's and loans crisis play in the financial crisis of 2008?

It set up the cycle of subprime mortgages. As more mortgages were collateralized after the crisis, more investors were seeking yields and could get higher yields from these loans. These continued to grow, as demand grew, and set up a system that could collapse.

If velocity were constant while M2 rose from $10 trillion to $11 trillion in a single year, what would happen to nominal GDP?

It would go up by 10% 10 * 2 = 20 for t = 1 MV + PY 11 * 2 = 22 for t = 2 GDP = 22-20/20 = 2/20 = .10

2008 fed res bails out aig

Just a day after Lehman is allowed to collapse, the Fed steps in to rescue American International Group (AIG), the largest insurer in the United States, with an $85 billion loan. Hours earlier, credit agencies had downgraded AIG, which had bet heavily in the credit default swap market, further undermining investor confidence. Policymakers believe that, unlike Lehman, AIG is "too big to fail" and a collapse would trigger cascading failures throughout the U.S. and global financial systems.

Describe the role the reserve primary fund played in the financial crisis

Just after Lehman's collapse, Reserve Primary Fund, one of the largest MMMF, announced that it could only pay $0.97 per dollar to its investors due to its exposure to Lehman's commercial paper. This announcement triggered to a massive withdrawal of funds across the whole MMMF field. This run could spread the crisis because banks securitized assets were financed by repos and commercial paper whose major buyers are the MMMF. This run would led to a liquidity spiral since MMMF wouldn't be available to provide funds, increase their haircuts and banks would need to fire-sell assets.

2009 g20 summit pushes financial regulation

Leaders from the Group of Twenty (G20), representing the world's leading economies, meet in London, where they pledge to triple funding for the International Monetary Fund and increase trade financing. The leaders do not make any major statement on increasing global stimulus spending, a focus of the United States ahead of the summit. Following a major push by France and Germany, the leaders do, however, announce plans to strengthen international financial regulation.

2008 'moral hazard' and lehman's collapse

Lehman Brothers, a major global investment bank and a fixture on Wall Street for more than 150 years, files for the largest bankruptcy in U.S. history. The announcement spooks many investors who had assumed the U.S. government would act to prevent a bank the size of Lehman from failing. However, U.S. Treasury and Fed leaders fear at the time that bailing out Lehman would create "moral hazard" within the banking industry.

quantity theory of money equation

M^d = (1/v) PY

Equilibrium in the money market would be expressed by which one of the following?

Ms = Md

2008 bush launches auto bailouts

On December 19, the George W. Bush administration announces plans to support two of the "Big Three" U.S. automakers, General Motors and Chrysler, with emergency financing totaling more than $17 billion; the third, Ford, avoids a bailout. In February 2009, the companies approach the government again for additional loans of more than $20 billion; by June, both have entered bankruptcy. After restructuring, the U.S. Treasury sells its remaining Chrysler stock in 2011 and its last GM stock in 2013, losing some $9 billion overall on its auto bailout programs.

2011 occupy wall street taps into discontent

On September 17, protesters begin occupying Zuccotti Park, near Wall Street in lower Manhattan, where they remain until authorities expel them in November. Objecting to growing wealth inequality and what they see as corruption and favoritism during the corporate bailouts, they inspire similar actions around the world. A year before, the so-called Tea Party movement had gained traction among Republicans with similar complaints against the TARP program, bank bailouts, and what they considered wasteful spending through Obama's stimulus package.

2010 dodd-frank financial overhaul signed

President Barack Obama signs into law a financial reform bill aimed at preventing future financial crises by giving the federal government new powers to regulate Wall Street. The bill, to be implemented over several years, includes the creation of a Consumer Financial Protection Bureau and a Financial Services Oversight Council to monitor market stability. The Federal Deposit Insurance Corporation gains the power to seize and dismantle troubled financial firms deemed "too big to fail," and proprietary trading—when banks invest for their own profit—is banned. The bill also limits the scope of banks' investments in hedge funds and private equity funds.

2017 mulvaney takes over CFPB

President Donald J. Trump appoints Mick Mulvaney, the head of the Office of Management and Budget, as acting director of the Consumer Financial Protection Bureau (CFPB), the financial watchdog agency created by Dodd-Frank. Critics accuse Mulvaney, who previously called the CFPB a "sick, sad joke," of undermining the agency's mandate by rolling back regulations, slowing enforcement measures, and favoring private lenders. In August 2018, the agency's top student-loan official resigns in protest.

2000-2001 fed res cuts int rate

Prompted by the burst of the dot-com bubble and the resulting recession, the U.S. Federal Reserve, led by Alan Greenspan, lowers its benchmark interest rate eleven times. Falling interest rates lead to an easy-credit environment, encouraging lending practices that prove unsustainable later in the decade. The ensuing credit bubble plays a large role in the run-up to the financial crisis.

The theory that money growth translates directly into inflation is the

Quantity theory of money

If the fed raises the IOER, this will cause banks to _________ the federal funds rate they are willing to pay other banks to borrow excess reserves.

Raise

The only solution available to a country experiencing extremely high rates of inflation is to

Reduce money growth

2017 dodd-frank repeal passes house

Republicans in the U.S. House of Representatives pass the Financial CHOICE Act, which would largely dismantle the Dodd-Frank reforms. Provisions include exempting many banks from stress tests, repealing the Volcker Rule, stripping the Consumer Financial Protection Bureau of much of its power, and easing many other regulations on financial institutions. However, the bill in this form fails to advance to the Senate.

Does money velocity fluctuate more in the short run, or the long run?

Short run

2007 subprime woes go global

Subprime mortgage problems spread worldwide as hedge funds and banks around the globe reveal substantial holdings of mortgage-backed securities. France's BNP Paribas announces on August 9 that there is no liquidity in the market for the assets held by three of its hedge funds, as investors reject these so-called toxic assets, which are rapidly losing their value. Other European banks follow with similar announcements. The European Central Bank immediately steps in to offer low-interest credit lines to support these banks. With lending markets drying up around the world, the central banks of the United States, the European Union, Australia, Canada, and Japan coordinate to inject liquidity into credit markets for the first time since 9/11.

2008 dow finishes worst week as fed intervenes

The Dow Jones Industrial Average suffers the worst week of losses in its history, dropping by more than 20 percent. During the course of the week, the Federal Reserve moves to make an additional $900 billion of short-term lending available to banks and announces plans to lend approximately $1.3 trillion to companies outside the financial sector. The central banks of the United States, the EU, Britain, China, Canada, Sweden, and Switzerland make coordinated interest rate cuts. The U.S. economy sheds 240,000 jobs in October, ushering in a period of heavy job losses that culminates in an unemployment rate of 10 percent a year later.

2008 fed announces quantitative easing

The Federal Reserve introduces a plan to make large-scale asset purchases, known as quantitative easing, to push down long-term interest rates and jumpstart economic activity. In March 2009, the Fed announces the purchase of $750 billion in mortgage-backed securities and $300 billion in U.S. Treasuries. In November 2010, the Fed launches a second round of purchases, known as QE2, and in 2012 a third, QE3. By the time the program is wrapped up in 2014, the Fed has expanded its balance sheet to more than $4 trillion, up from less than $1 trillion in 2008.

What is the difference between the GDP deflator and the CPI index?

The GDP deflator measures the cost of living whereas CPI measures the purchasing power of the dollar

2014 tar ends

The Treasury sells its remaining shares in Ally Financial, formerly the financing arm of General Motors, offloading its last major investment from the Troubled Asset Relief Program. The Obama administration announces that the program resulted in a $15 billion profit, with the government recouping $441 billion on the $426 billion disbursed. Critics maintain that the bailouts created a lasting moral hazard for banks and contributed to the polarization of American politics.

2008 government nationalizes fannie and freddie

The U.S. government announces it will seize control of federal mortgage insurers Fannie Mae and Freddie Mac, in what is considered Washington's most dramatic intervention in the credit crisis to date. The two firms are riddled with mortgage defaults, and federal regulators fear their collapse could lead to massive collateral damage for financial markets and the U.S. economy.

What is too big to fail? What are the arguments for and against bailing out large institutions?

The government's implicit willingness to bail out the creditors of a large intermediary causes the too-big-to-fail (TBTF) problem, contributing to moral hazard. For example, if investors believe that an institution has TBTF status, they perceive relatively less risk when lending to it. Thus, the TBTF intermediary can borrow more cheaply and take on more risk. Dodd-Frank could fail to eliminate TBTF if investors doubt the willingness of the government to let TBTF banks fail.Dodd-Frank attempts to limit the mechanisms for government bailouts. It constrains Fed lending to individual nonbanks, limits the FDIC's guarantee powers, subjects large institutions to regular "stress tests," requires systemically important financial institutions (SIFIs) to have living wills, and calls for higher capital requirements.

What is the velocity of money?

The number of times each dollar is used

Which of the following topics were pivotal to the crisis, but not included in the timeline you were required to read?

The role of the savings and loan crisis, The global savings glut and flight to quality, When the reserve primary fund "broke the buck" which sent money markets into chaos

One way the fed can inject reserves into the banking system is to increase

The size of the fed's balance sheet through purchasing securities

The trend in real GDP growth is determined by

The structure of the economy and the rate of technological progress, which is fairly stable

To use money growth as a short-term monetary policy instrument, a central bank must believe that

There is a stable link between the monetary base and the rate of inflation

2008 paulson unveils tarp rescue plan

Treasury Secretary Henry Paulson unveils a rescue plan dubbed the Troubled Asset Relief Program, or TARP, which aims to use $700 billion of U.S. taxpayer money to stabilize markets. It also proposes buying troubled assets from the country's largest financial firms in the hopes of restoring confidence in credit markets. That November, Paulson abandons the element of the plan aimed at buying these so-called toxic assets.

2018 trump signs dodd-frank reform bill

Trump signs the Economic Growth, Regulatory Relief, and Consumer Protection Act, the first major financial legislation since Dodd-Frank. The bill, passed with bipartisan support in Congress, keeps the Dodd-Frank framework but exempts many smaller banks from the regulatory scrutiny imposed after the crisis. Now, only financial institutions with more than $250 billion in assets, rather than $50 billion, will be subject to increased federal oversight, though the bill gives the Fed discretion to include smaller banks if it deems necessary.

2009 us banks stress tested

U.S. regulators led by the Federal Reserve release the results of the first banking stress test, which set out to assess the health of the country's largest financial institutions. Ten of the nineteen companies tested are required to raise additional capital, a total of $75 billion across the system. The subsequent Dodd-Frank financial overhaul formalizes the stress test process, leading to yearly tests for U.S. financial institutions with a certain level of assets.

Federal funds loans are

Unsecured short term loans of reserves between banks

Key assumptions behind the quantity theory of money include that the

Velocity of money is constant

2008 bank failures signal end of an era

Washington Mutual is seized by the Federal Deposit Insurance Corporation (FDIC) and declares bankruptcy, the largest bank failure in U.S. history. Several days later, another major U.S. bank, Wachovia, is purchased by Wells Fargo. Meanwhile, the two largest U.S. investment banks, Goldman Sachs and Morgan Stanley, announce they will convert to bank holding companies, exposing them to additional government regulation but giving them access to more loans from the Fed. The move marks the end of independent investment banks, symbols of Wall Street's success in the second half of the twentieth century.

Can the fed stabilize inflation with money growth if velocity not constant but is predictable?

Yes

Did the fed bail out AIG?

Yes

If velocity is constant, would a monetary policy that fixed the growth rate of money work to control inflation?

Yes

Does money growth reduce the purchasing power of money?

Yes, but only if money demand is constant

The ______ lower bound is the notion that nominal interest rates cannot go below zero, whereas the ________ lower bound is the rate at which intermediaries will switch to holding cash.

Zero, Effective

The key to the success of forward guidance as a monetary policy tool is

credibility

Describe the process of investing in a money market fund, who are the investors, and who are the borrowers?

investors are lenders and issuers are borrowers

If the market federal funds rate were below the target rate, the response from the fed would likely be to

raise the IOER rate

What is the Greenspan Put?

the idea the federal reserve will constantly rescue the market.

What is meant by lender of last resort?

the use of government funding to save a private institution from imminent failure

A good monetary policy instrument is

tightly linked to monetary policy objectives