Econ 2035 chapter 15

What was the approximate peak amount of borrowing from the Fed during the Financial Crisis of 2007-2009?

$1 trillion

One of the extraordinary policy actions taken by the Fed in response to the financial crisis of 2007-2009 was making huge asset purchases. These asset purchases greatly increased all of the following

Bank reserves, the size of the Feds balance sheet, the monetary base

All of the following are associated with rising inflation

Income redistribution, firms hesitating to enter into long-term contracts with suppliers, families having trouble deciding how much to save for retirement

What statement accurately describes the Fed's control of discount policy?

It controls discount policy less completely than it controls open market operations

What new policy tools for controlling reserve balances did the Fed introduce during the Financial Crisis of 2007-2009?

The Fed began to pay interest on reserves. By paying a higher interest rate, it can encourage banks to maintain their reserve holdings. The Fed initiated reverse repurchase agreements, where it sells a security to a financial firm while at the same time promising to buy the security back the next day. By raising the interest rates it is willing to pay on these loans, the Fed reduces the willingness of its counterparties to lend at a lower rate. The term deposit facility gives the Fed another tool in managing bank reserve holdings. The more funds banks place in term deposits, the less they will have available to expand loans and the money supply.

How many times has the Fed changed reserve requirements since 1993?

never

If the Fed wished to decrease the money supply, it could

raise the interest rate it pays on reserves

Depository institutions such as savings and loans have deposits with the Fed that ________, and financial institutions such as Fannie Mae have deposits with the fed that ________.

receive interest; do not receive interest

In the federal funds market diagram, an open market sale by the Fed

shifts the reserve supply curve to the left

When did the Fed first begin to use open market operations as a policy tool?

the 1920s

Reserve requirements are set by

the Fed

What was the goal of Operation Twist?

to reduce long-term interest rates and increase short-term interest rates

The Open Market Trading Desk is

linked electronically to a group of private securities firms that the Fed has selected to participate in open market operations.

Inflation is an economic problem because it

makes prices less useful as signals for resource allocation

Which types of unemployment still occur even when the economy is considered to be operating at full employment?

At full employment, there will still be frictional and structural unemployment.

Which central bank has its exchange rate as a focus of its monetary policy?

Bank of Canada

Under which chair did the Fed implement the policy of inflation targeting?

Bernanke

What is the difference between defensive and dynamic open market operations?

Dynamic open market operations are intended to change monetary policy as directed by the FOMC. Defensive open market operations are intended to offset temporary fluctuations in the demand or supply for reserves, not to carry out changes in monetary policy.

What statements are true?

Each Federal Reserve Bank maintains its own discount window, before 1980, the Fed rarely made loans to banks which were not members of the Federal Reserve System, since 1980, all depository institutions have had access to the discount window.

According to the Taylor rule, what should the federal funds rate target be if inflation is 5%, the target rate of inflation is 2%, the equilibrium real federal funds rate is 2%, full-employment real GDP is $9 trillion, and current real GDP is $8.55 trillion?

Fed funds rate target = 5% + 2% + (1/2)(3%) + (1/2)(-5%) = 6%.

The Fed ended QE3 in

October 2014

What describes the relationship between the actual federal funds rate and that suggested by Taylor's rule following the recovery from the 2001 recession?

The federal funds rate was below that suggested by Taylor's rule

In the United States from 1981 to 1983, the money supply ________ and the inflation rate ________.

increased; decreased

An open market purchase

increases the monetary base

An open market purchase

increases the price of Treasury securities and decreases their yield

The ECB has emphasized what type of goal for monetary policy?

inflation targeting

The Fed's inability to instantaneously observe changes in inflation and economic growth result in

information lag

Traditionally, Fed policymakers have been ________ to use higher interest rates to head off potential asset bubbles ________.

hesitant; because it may cause a slowdown in the economy

Rates of inflation in the hundreds or thousands of percent per year are known as

hyperinflation

In 2016, the Bank of Japan

instituted a negative interest rate on deposits it receives from Japanese banks, effectively requiring banks to pay the Bank of Japan for keeping their deposits

During the financial crisis, the Fed introduced three new policy tools connected with bank reserve accounts. What are those three tools?

interest on reserve balances, overnight reserve repurchase agreement facility, term deposit facility

Most economists believe that a zero rate of unemployment

is inconsistent with a well-functioning economy

The Fed's goal of interest rate stability

is motivated by political pressure as well as by a desire for a stable saving and investment environment

All of the following arguments are presented in favor of inflation targeting

it would draw attention to what the central bank can achieve in practice, it would provide an anchor for inflationary expectations, it would promote accountability by providing a yardstick by which policy can be measured

All of the following arguments are made against inflation targeting

rigid numerical targets would diminish the flexibility of monetary policy, the Fed would need to depend on future forecasts of inflation since monetary policy acts with a lag, holding the Fed accountable for low inflation may make it difficult for elected officials to monitor whether the Fed is supporting good overall economic policy

As a result of an open market purchase, bank reserves

rise and interest rates fall

Temporary, short-term discount loans to banks in areas in which agriculture and tourism are important are known as

seasonal credit

The unemployment that is caused by changes in the economy, such as shifts in manufacturing techniques, increased use of computers and electronic machines, and increases in the production of services instead of goods, is called

structural unemployment

In addition to the Fed, which other central bank pursued unusual monetary policy following the financial crisis of 2007-2009?

the European Central Bank, the Bank of Japan, and the Bank of England

All of the following central banks took action to stimulate their economies following the 2007-2009 financial crisis and recession by implementing negative interest rates

the European Central Bank, the Swiss National Bank and Denmark's National Bank

Increases in interest rates are often blamed on

the Fed

The Fed uses operating targets as well as intermediate targets because

the Fed controls intermediate targets only indirectly

A falling dollar makes U.S. goods

less expensive abroad and increases the volume of U.S. exports

The policy directive from the FOMC is carried out by

the account manager at the Federal Reserve Bank of New York

The benchmark default-free interest rate of the financial system is generally considered to be

the interest rate on the 10-year Treasury note

The discount window is

the means by which the Fed makes discount loans to banks

By the time of the annual monetary policy conference in Jackson Hole, Wyoming in 2016,

the monetary base and the Fed's balance sheet remained very large, and the target for the federal funds rate had only slightly risen

Primary credit is only a backup source of funds for healthy banks since

the primary credit rate is set above the federal funds rate

All of the following statements about secondary credit are true

the secondary credit interest rate is set above the primary credit rate, it is intended for banks not eligible for primary credit, borrowers of secondary credit are less financially healthy

Since 1980, discount loans have been available

to all depository institutions

What are accurate descriptions of open market operations prior to 2008?

It was used to affect the market for bank reserves, it was used to control the federal funds rate, it involved buying and selling short-term Treasury securities

On which type of unemployment can monetary policy have the most effect? Why?

Monetary policy has the most effect on cyclical unemployment by stimulating the economy when its in a recession.

Under which circumstance is the Fed most likely to carry out a defensive open market operation?

if a snowstorm results in a delay in check clearing, resulting in an increase in the Federal Reserve float

Expansionary monetary policy consists of all of the following

lower interest rates, increased monetary base, increased money supply

Interest rate fluctuations

make it difficult for households and firms to plan for the future

A rising dollar makes U.S. goods

more expensive abroad and decreases the volume of U.S. exports

The Fed can implement open market operations

more rapidly than either changes in the discount rate or changes in reserve requirements

The third round of quantitative easing, announced in September 2012, was focused on purchases of

mortgage-backed securities

How did Operation Twist affect the monetary base?

no change

Discount loans intended for banks that are NOT financially healthy are called

secondary credit

In a matched sale-purchase transaction, the Fed

sells securities to a dealer and the dealer agrees to sell them back

In the federal funds market diagram, a decrease in the required reserve ratio

shifts the demand curve for reserves to the left

Sally Jones lost her job at a steel company because of a permanent decline in the demand for steel. Sally Jones is considered by economists to be

structurally unemployed

Which of the Fed's three new policy tools connected with bank reserve accounts is the least important?

term deposit facility

The bursting of the dot-com bubble contributed to the

recession of 2001

The bursting of the housing bubble was a key factor in causing the severity of the

recession of 2001

When financial markets and institutions are NOT efficient in matching savers and borrowers

resources are lost

A matched sale-purchase transaction is also known as a

reverse repo

In December 2008, the FOMC cut its target for the federal funds rate from 1% to a range from 0% to 0.25%, and it remained at this level for

7 years

What is a matched sale-purchase transaction (also known as a reverse repo)?

A matched sale-purchase transaction is when the Fed sells securities to primary dealers, and the dealers agree to sell them back to the Fed in the near future.

What statement about the natural rate of unemployment is correct?

Currently, most economists think that the natural rate is about 5%

How did the federal funds rate compare to that suggested by Taylor's rule following the 2001 recession and during the Financial Crisis of 2007-2009? How would proponents of Taylor's rule evaluate monetary policy in each period.

Following the recession of 2001, the federal funds rate was consistently below that suggested by Taylor's rule. This indicates that monetary policy was too loose and, according to some economists, may have contributed to the housing bubble. During the Financial Crisis of 2007-2009, Taylor's rule suggested that the federal funds rate should be negative, indicating that the Fed should maintain a very low rate and perhaps engage in quantitative easing (since the federal funds rate cannot be negative).

What country experienced hyperinflation during the 1920s?

Germany

What best describes a policy of inflation targeting?

It allows monetary policy to focus on inflation and inflation forecasts except in the case of severe recession.

What accurately describes the Fed's inflation target?

It seeks to maintain an average inflation rate of 2% per year

What is an intermediate target?

M2

What statement is correct?

Open market purchases are expansionary and open market sales are contractionary

What was the name of the plan, enacted in 2011, in which the Fed bought $400 billion worth of long-term securities while selling $400 billion worth of short-term securities?

Operation Twist

According to Taylor's rule, all of the following variables help explain the behavior of the federal funds rate

Output gap, current inflation, inflation gap

What is quantitative easing? What was the Fed's objective in implementing quantitative easing?

Quantitative easing is a policy when a central bank attempts to stimulate the economy by buying long-term securities. The Fed's objective was to reduce the interest rates on mortgages and on 10-year Treasury notes. Lower interest rates on mortgages could help to spur new home sales. And lower interest rates on 10-year Treasury notes could help to lower interest rates on corporate bonds, thereby increasing investment spending on physical capital.

What has been the approach of the European Central Bank to monetary targeting?

The European Central Bank has emphasized the importance of price stability, defined as an inflation range from 0% to 2%.

What is meant by inflation targeting? Does the Fed engage in inflation targeting?

Under inflation targeting a central bank commits to conduct policy to satisfy a publicly announced inflation target within a given time frame. In 2012, the Fed adopted an inflation target.

Describe the temporary lending facilities that the Fed set up during the Financial Crisis of 2007-2009.

Under the primary dealer credit facility, primary dealers could borrow overnight using mortgage-backed securities as collateral. Under the term securities lending facility, the Fed would loan up to $200 billion of Treasury securities in exchange for mortgage-backed securities. Under the commercial paper funding facility, the Fed purchased three-month commercial paper issued by nonfinancial corporations. Under Term Asset-Backed Securities Loan facility, the Federal Reserve Bank of New York extended three-year or five-year loans to help investors fund the purchase of asset-backed securities.

When is the Fed likely to return to to using normal monetary policy procedures?

While the Fed may eventually return to normal monetary policy procedures, it is unlikely to do so in the near future

The Fed's monetary policy tools

have allowed the Fed to achieve its monetary policy goals indirectly

The Fed was created

after financial panics in the late 1800s and early 1900s

A Federal Reserve repurchase agreement involves

an agreement by a dealer to buy back securities she has sold to the Fed

If the account manager does NOT use a Federal Reserve reverse repurchase agreement or a matched sale-purchase transaction in carrying out open market operations, he will use

an outright purchase or sale

Dynamic open market operations

are aimed at achieving changes in monetary policy

Open market operations

are more flexible than other traditional policy tools

Defensive open market transactions

are used to offset disturbances to the supply or demand for reserves

In 2006, the Bank of Japan

began to scale back its expansionary policy, only to return to an expansionary policy following the financial crisis

What interest rates tends to fluctuate the most?

federal funds rate

Intermediate targets are

financial variables, such as interest rates or monetary aggregates, the Fed believes will help it to achieve policy goals

A consequence of the impact lag is that the Fed

might not be able to correct a mistaken policy soon enough

Because of the breakdown in the relationship between the growth of the money supply and inflation, since 1993, the Fed

no longer announces targets for M1 or M2

What is an operating target?

non borrowed reserves

The information lag facing the Fed is

the delay in receiving accurate information about the state of the economy

The inflation gap can best be described as

the difference between inflation and its target

An important problem facing the Fed is that

the goals for economic growth and price stability may conflict in the short run

The output gap can best be described as

the percentage difference between real GDP and its potential

The impact lag facing the Fed is

the time required for monetary policy changes to affect output, employment, and prices

The Fed has attempted to solve the problems of being unable to directly control the variables that determine economic performance and the timing lags in observing and reacting to economic fluctuations by

using targets to meet its goals

In 2016, savings rates in Japan, Germany, Denmark, Sweden, and Switzerland

were at their highest level since 1995, indicating that negative interest rates were not increasing consumer spending

When the Fed raised its target for the federal funds rate in 2015, it set the interest rate it pays on overnight reverse repurchase agreements at

0.25%

When the Fed raised its target for the federal funds rate in 2015, it set the interest rate it pays on excess reserves at

0.50%

What are the goals of monetary policy?

High employment, economic growth, price stability

What is an accurate description of the steps by which the FOMC causes the actual federal funds rate to rise into its target range when it votes to raise the federal funds rate target?

IOER is increased → this affects depository institutions that can borrow and lend in the federal funds market AND are paid interest on their deposits with the Fed → this pushes the federal funds rate to the top of the target range → federal funds rate rises into this new range.

How does the interest paid on reserves set a floor for the federal funds rate?

If the federal funds rate was lower than the interest on reserves, banks could borrow from one another at a low rate and earn a risk-free return on reserves. Competition between banks to carry out the risk-free arbitrage would force the federal funds rate up to the interest rate on reserves.

What statement concerning seasonal credit is TRUE?

Improvements in credit markets have reduced the need for a seasonal credit facility

What is an accurate description of the steps by which the FOMC causes the actual federal funds rate to rise into its target range when it votes to raise the federal funds rate target?

ON RRP is increased → this affects certain nonbank financial institutions that can borrow and lend in the federal funds market BUT ARE NOT paid interest on their deposits with the Fed → this keeps the federal funds rate above the bottom of the target range → federal funds rate rises into this new range.

Suppose banks incur heavy losses and become more cautious, increasing their demand for reserve. Make use of a graph of the federal funds market to show how the Fed can use open market operations to maintain the same federal funds rate.

The Fed will conduct open market purchases, increasing the supply of reserves (shifting it to the right) by a sufficient amount to ensure that the federal funds rate remains at its current rate.

Suppose the current federal funds rate is 0.25% and the Fed chooses to raise its target to 0.5%. Make use of a graph of the federal funds market to show how it will use open market operations to accomplish this.

The Fed will conduct open market sales, reducing the supply of reserves (shifting it to the left) until the new equilibrium federal funds rate rises to 0.5%.

What statement is correct?

The discount rate is generally above the federal funds rate

Describe the three types of unemployment

The three types of unemployment are frictional, structural, and cyclical. Frictional unemployment occurs when some people move into and out of the job market or when people are between jobs. Structural unemployment refers to unemployment resulting from changes in the structure of the economy. Cyclical unemployment is unemployment associated with recessions.

What statement is correct?

The volume of defensive open market operations is much greater than the volume of dynamic open market operations

What statement is correct?

The volume of open market operations is determined solely by the Fed

How were open market operations conducted prior to 1935?

They were carried out by the district Federal Reserve banks

The FOMC states its overall objectives for interest rates in

a policy directive

If the account manager finds that the current level of bank reserves is greater than the desired level indicated in the most recent directive from the FOMC, he will

conduct an open market sale

In order to increase its target for the federal funds rate, the Fed would normally

conduct open market sales

An open market sale

decreases the price of Treasury securities and increases their yield

The original Federal Reserve Act

did not specifically mention open market operations

John Smith leaves his job in New York to go to California in hopes of finding a better one. If John Smith is unemployed while searching for a job in California, economists would consider him to be

frictionally unemployed

The Fed tends not to use discount policy as its principal tool in influencing the money supply since

it does not have as much control over discount loans as it has on open market operations

If the Fed desired to reduce the federal funds rate

it would conduct an open market purchase, increasing reserve supply

Reserve requirements are changed

less frequently than open market operations are conducted and less frequently than the discount rate is changed

Congress established the FOMC because

of a lack of coordination among district banks in carrying out open market operations

High employment spurs economic growth because high employment

often leads to high rates of investment

How does the Open Market Trading Desk conduct its operations?

over-the-counter electronically with private securities dealers

How can the Fed reduce the implicit tax on banks resulting from reserve requirements?

paying interest on reserves

Primary dealers are those

permitted to trade directly with the Fed

When economists and policymakers refer to the Fed's dual mandate, they are referring to

price stability and maximum employment

Discount loans available to healthy banks which can be used for any purpose are called

primary credit

The Employment Act of 1946 codified the federal government's commitment to

promote high employment consistent with price stability

During and after the financial crisis of 2007-2009, the Fed greatly increased the supply of reserves through three rounds of quantitative easing by

purchases of both long-term Treasury securities and mortgage-backed securities

When all workers who want jobs have them and the demand for and supply of labor are in equilibrium

unemployment is at its natural rateWhich of the following statements about the natural rate of unemployment is correct?

The assumption that reserves are scarce

was accurate prior to the financial crisis of 2007-2009 but not following the crisis.