ECON 202 EXAM 2
With a required reserve ratio of 20 percent, an increase in reserves of $10,000 could lead to a maximum increase in checking account deposits in the entire banking system of
50,000
The Federal Reserve Bank's Board of Governors consists of ____ members appointed by the president of the U.S. to 14-year, non-renewable terms.
7
shadow banking system
Investment banks, money market mutual funds, hedge funds and other financial firms engaged in similar activities.
Which of the following is included in M2 but not M1?
Money market deposit accounts in banks
To increase the money supply, the Federal Reserve could
conduct an open market purchase of Treasury securities.
To decrease the money supply, the Federal Reserve could
conduct an open market sale of Treasury securities
Why do we accept dollar bills as a medium of exchange?
confidence that the dollar bill will be accepted by others
discount rate
interest rate the fed charges on loans (called discount loans) to banks
How do banks make a profit?
interest rates
congress in 1934 established the federal deposit insurance corporation
-to insure deposits in most banks up to a limit, which is currently 250,000 per deposit
fed purchase of treasury securities increases bank reserves
-when the fed buys treasury securities the sellers of the securities deposit the fed payment into their checking account deposits, increasing bank reserves
How banks create money examples
-with a required reserve ratio of 10%, Bank of america's required reserves = 100 and excess reserves = 900 -bank loans $900 of excess reserves and increases the borrower's checking account deposit by 900 -by making the 900 loan from excess reserves, the bank has increased the money supply by 900
Suppose that Deja owns a McDonald's franchise. She decides to move her restaurant's checking account to Wells Fargo, which causes the changes shown on the following T-account. If the required reserve ratio is 0.15, or 15 percent, and Wells Fargo currently has no excess reserves, the maximum loan Wells Fargo can make as result of this transaction is
100,000-15,000= 85,000
the United States is divided into _______Federal Reserve Districts.
12
One of the board members is appointed to a ___ year, renewable term as the chairman
4
Lender of last resort
function when banks face liquidity problems
Very high rates of inflation are called
hyperinflation
nominal GDP
income in the country
how do banks create money
loans
(commercial and consumer) largest asset
federal reserve system board of governors
-7 members appointed by the president to 14 yr nonrenewable terms -chair appointed to 4 yr renewable term
Monetary policy
-actions the fed takes to manage the money supply and interest rates to pursue macroeconomic policy objectives
Central Bank Monetary Authority
-an institution designed to oversee the banking system and regulate the quantity of money in the economy -a monopolized and often nationalized institution given privileged control over the production and distribution of money and credit
federal reserve system three parts
-board of governors -federal reserve district banks -federal open market committee
the federal reserve's first test as lender of last resort
-in the early years of the great depression, many banks were hit with bank runs. the fed declined to make loans to many of them because they worried that banks experiencing runs has made bad loans and other investments -the fed believed that making loans to banks that were in financial trouble because of bad investments might reduce the incentive bank mangers had to be careful in their investment decisions= moral hazard problem -more than 5000 banks failed during the early 1930s
Runs on Investment Banks
-investment banks funded long term investments with short term loans by maturity mismatch -no problems occurred as long as lenders renewed their short term loans -the run on investment banks occurred when lenders did not renew their short term loans
the firms in the shadow banking system were more vulnerable to runs
-shadow banking system had no federal deposit insurance -these firms were also more highly leveraged than commercial banks, and held a significant amount of mortgage-backed securities
Real-World Deposit (Money) Multiplier
-the real world deposit (money) multiplier is considerably smaller (about 1.6 during normal periods) than the simple deposit multiplier -banks may not lend out as much as we predict, either because they want to keep excess reserves or they cannot find credit-worthy borrowers -consumer keep some currency out of the bank; that currency cannot be used as required reserves
What is price deflation?
A fall in the price level.
What is meant by Professor Spencer's statement "This printing of money 'will keep the [deflation] wolf from the door'"?
An increase in the money supply that exceeds the rate of growth of GDP will increase the price level.
money
Assets that people are generally willing to accept in exchange for goods and services or for payment of debts.
"China now has one of the highest [required reserve] ratios in the world, economists say, even though many businesses are starved of credit..."
Being starved for credit means Chinese businesses cannot get loans.
Why would deflation cause "shoppers to hold back," and what does Evans-Pritchard mean when he says, "Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop"?
Consumers delay purchases, expecting prices to fall more, and the lack of demand causes prices to fall further.
largest liability
Deposits (checking, saving)
excess reserves formula
Excess reserves are equal to total reserves minus required reserves
What is the "shadow banking system"?
Financial firms that raise money from investors and provide it to borrowers
What is the "shadow banking system"?
Financial firms that raise money from investors and provide it to borrowers.
If Irving Fisher was correct in his prediction about the value of velocity, then the quantity equation can be written to solve for the inflation rate as follows:
Inflation rate = Growth rate of the money supply- Growth rate of real output.
The Federal Reserve uses two definitions of the money supply, M1 and M2, because
M1 is a narrow definition focusing more on liquidity, whereas M2 is a broader definition of the money supply.
Monetary Aggergates : M1
M1= currency in circulation + checking account deposits (paper money and coins)
Suppose you withdraw $1,000 from a money market mutual fund and deposit the funds in your bank checking account. How will this action affect M1 and M2?
M2 will not be affected, but M1 will increase.
Monetary Aggergates : M2
M2= M1 + saving type account deposits (saving accounts, small time deposits, money market mutual funds)
bank panic
Many banks experience bank runs at the same time. Banking system could be in trouble
What is a "classic type of run"?
Many depositors simultaneously decide to withdraw their money from a bank.
Why might investors in a money market mutual fund, for example, be more likely to "rush to the exits" if they heard bad news about the fund's investments, than would bank depositors if they received bad news about their bank's investments?
Money market mutual funds are not protected by deposit insurance, as commercial banks' deposits are through the Federal Deposit Insurance Corporation (FDIC).
What did Geithner mean by the "non-bank financial system"?
Money market mutual funds, hedge funds, and other financial firms that raise money from investors and provide it to firms and households.
Which one of the following is not one of the policy tools the Fed uses to control the money supply?
Moral suasion
required reserves formula
Required reserves are equal to the required reserve ratio multiplied by the amount of deposits.
Why would deposit insurance provide the banking system with protection against runs?
Since most depositors are insured, it is less likely that panicked buyers will simultaneously withdraw funds.
Which tool is the most important?
The Fed conducts monetary policy principally through open market operations.
Federal Open Market Committee (FOMC)
The Federal Reserve committee responsible for open market operations and managing the money supply in the United States. -meets every 6 weeks -12 voting members: 7 board of governors, president of NY fed, and 4 presidents from other 11 fed banks
open market operations
The buying and selling of Treasury Securities by the Federal Reserve in order to control the money supply
required reserve ratio
The minimum fraction of deposits that banks are required by law to keep as reserves
Based on the quantity theory of money, if velocity is constant, inflation is likely to occur when:
The money supply grows at a faster rate than real GDP.
Open market operations refer to the purchase or sale of ________ to control the money supply.
U.S. Treasury securities by the Federal Reserve
Systemic Risk in the Banking System
With fractional reserve banking, the maturity mismatch between deposits and loans, contagion and asset deflation, the banking system faces an inherent system-wide risk.
Is there a connection between the Chinese central bank imposing a higher required reserve ratio on banks and Chinese businesses being starved for credit? Briefly explain.
Yes, higher required reserve ratios require banks to keep more capital as reserves instead of making loans.
Hyperinflation is caused by
a high rate of growth in the money supply
If the economy adjusts through the automatic mechanism, then a decline in aggregate demand causes
a recession in the short run and a decline in the price level in the long run.
In the United States, each bank panic in the late nineteenth and early twentieth centuries was accompanied by
a recession.
A supply shock is
a sudden increase in the price of an important natural resource, resulting in a leftward shift of the SRAS curve
Which of the following is usually the cause of stagflation?
a supply shock as a result of an unexpected increase in the price of a natural resource
Stagflation occurs when
a supply shock shifts the SRAS to the left, increasing the price level and decreasing actual GDP
If the economy is initially at full-employment equilibrium, then an increase in aggregate demand causes _____________ in real GDP in the short run and ___________ in the price level in the long run.
an increase; an increase
Multiple banks selling assets to meet liquidity needs can cause ________ _________ and cause healthy banks to become insolvent.
asset deflation--> price of assets go down
fractional reserve banking
bank keep < 100% of deposits as reserves
During a bank run or panic, why can't the bank(s) call in their loans to pay the depositors?
because the loans are long term -maturity mismatch between deposits and loans cause banks during a bank panic to have liquidity problems
interest rate on bank reserve deposits at the fed
by increasing the interest rate on bank reserves deposited at the fed, the fed can increase the level of excess reserves banks are willing to hold thereby decreasing bank lending and decreasing money supply
domain of commercial banks
by raising money from investors and lending it directly or indirectly to firms and households, these firms were carrying out a function
Stagflation is a
combination of inflation and recession
If households in the economy decide to take money out of checking account deposits and put this money into savings accounts, this will initially
decrease M1 and not change M2
An increase in the amount of excess reserves that banks keep _________ the value of the real-world deposit multiplier.
decreases
Which of the following is the largest liability of a typical bank?
deposits
reserves
deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve
income
earnings over a period of time
Whenever banks gain reserves and make new loans, the money supply ___________; and whenever banks lose reserves, and reduce their loans, the money supply __________.
expands; contracts
during financial crisis
fed provided discount loans to investment banks during the financial crisis
federal reserve does what to banks experiencing liquidity problems during a banking panic that cannot borrow funds elsewhere?
federal reserve established to make loans to banks
bank run
many depositors simultaneously decide to withdraw their money from a bank. one bank can . handle by borrowing from other banks
central bank controls what
money- quantity of money in a country (affects interest rates, spending in short run) (doesn't affect income and wealth in long run)
The financial firms of the shadow banking system were
more vulnerable than commercial banks to bank runs because they were more highly leveraged than commercial banks
The financial firms of the shadow banking system were
more vulnerable than commercial banks to bank runs because they were more highly leveraged than commercial banks.
wealth
net worth= assets- liabilities
when the federal reserve acts as a lender of last resort, does that represent a bail out of the banks?
no- if a bail out then got to let them fail
According to the quantity theory of money, if velocity does not change, when the money supply of a country increases, what will occur?
nominal GDP will increase
To decrease the money supply, the Federal Reserve could
raise the required reserve ratio.
three tools of monetary policy
reserve requirement, discount policy, open market operations -the fed conducts monetary policy primarily thru open market operations
required reserves
reserves that a bank is legally required to hold, based on its checking account deposits
excess reserves
reserves that banks hold over and above the legal requirement excess reserves = actual reserves - required reserves
three key assets
reserves, loans, securities
To offset (balance) the effect of households and firms deciding to hold more of their money in checking account deposits and less in currency, the Federal Reserve could
sell Treasury securities.
If, during a deposit expansion, not all money gets redeposited into the banking system and some leaks out as currency, then the real world multiplier is
smaller than 1/RR
When the Federal Reserve sells Treasury securities in the open market,
the buyers of these securities pay for them with checks and bank reserves fall.
Which of the following refers to the minimum fraction of deposits banks that are required by law to keep as reserves?
the required reserve ratio
When the Federal Reserve purchases Treasury securities in the open market,
the sellers of such securities deposit the funds in their banks and bank reserves increase.
The quantity theory of money is better able
to explain the inflation rate in the long run.
securities
treasury bills
Governments sometimes allow hyperinflation to occur because
when governments want to spend more than they collect in taxes, central banks increase the money supply at a rate higher than GDP growth, often resulting in hyperinflation
fed sale of treasury securities decreases bank reserves
when the fed sells treasury securities the buyers of the securities pay with checks written on their checking account deposits, decreasing bank reserves -fed sell treasury securities in order to reduce money supply
The ________ the reserve ratio, the ________ the money multiplier.
smaller; larger
