MB Exam 3

In the simple deposit expansion model, if the Fed purchases $100 worth of bonds from a bank that previously had no excess reserves, deposits in the banking system can potentially increase by

$100 times the reciprocal of the required reserve ratio.

If a bank has excess reserves of $10,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20%, then the bank has actual reserves of

(80,000x0.2)+10,000=26,000

A simple deposit multiplier equal to four implies a required reserve ratio equal to

25 percent

If the required reserve ratio is 10 percent, currency in circulation is $1,200 billion, checkabledeposits are $1,600 billion, and excess reserves total $2,500 billion, then the excess reserves-checkable deposit ratio is

2500/1600=1.56

If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkabledeposits are $1,000 billion, and excess reserves total $1 billion, then the monetary base is

400B + 1B + (400*.1) = 501B

In the simple deposit expansion model, if the banking system has excess reserves of $75, and the required reserve ratio is 20%, the potential expansion of checkable deposits is

75x5= $375

Suppose that from a new checkable deposit, First National Bank holds two million dollars invault cash, eight million dollars on deposit with the Federal Reserve, and one million dollars inrequired reserves. Given this information, we can say First National Bank has ________ milliondollars in excess reserves.

8+2-1=9

Which of the following criteria need NOT be satisfied for choosing a policy instrument?

A) The variable must be measurable. B) The variable must be controllable. C) The variable must be predictable. D) The variable must be transportable.****

The government safety net creates both an adverse selection problem and a moral hazard problem. Explain

Adverse selection refers to the problem that arises when individuals or institutions with the highest risk are the most likely to participate in a program or take advantage of a safety net. In the context of the government safety net, this means that banks that are riskier or more likely to fail may be more likely to take advantage of deposit insurance or other government programs, which can increase the overall risk in the financial system. Moral hazard, on the other hand, refers to the problem that arises when individuals or institutions take on more risk than they otherwise would because they are protected by a safety net. In the context of the government safety net, this means that banks may take on more risk or engage in riskier activities because they know that they are protected by deposit insurance or other government programs. This can increase the overall risk in the financial system and potentially lead to financial instability.

The relationship between borrowed reserves (BR), the nonborrowed monetary base (MBn), and the monetary base (MB) is

BR = MB-MBn

A bank that has excess reserves of $6,000 and demand deposit liabilities of $100,000 when the required reserve ratio is 20%. If the reserve ratio is raised to 25%, the bank's excess reserves will be

Currently, the bank has $100,000 in demand deposit liabilities and a required reserve ratio of 20%. Therefore, the bank is required to hold $20,000 (20% of $100,000) in reserves. Since the bank has excess reserves of $6,000, it is currently holding $26,000 in total reserves ($20,000 required reserves + $6,000 excess reserves). If the reserve ratio is raised to 25%, the bank will be required to hold $25,000 (25% of $100,000) in reserves. Since the bank currently has $26,000 in total reserves, it already exceeds the new reserve requirement of $25,000. Therefore, the bank will still have excess reserves of $1,000 after the reserve ratio is raised to 25%.

The majority of members of the Federal Open Market Committee are

Federal Reserve Bank presidents.

A bank has excess reserves of $1,000 and demand deposit liabilities of $80,000 when thereserve requirement is 25 percent. If the reserve requirement is lowered to 20 percent, the bank's excess reserves will be

Initially, the bank has $80,000 x 0.25 = $20,000 in required reserves, so its excess reserves are $1,000. After the reserve requirement is lowered, the bank's required reserves will decrease to $16,000, which means its excess reserves will be: Excess reserves = Vault cash + Deposits with Federal Reserve - Required reserves Excess reserves = $1,000 + ($80,000 x 0.20) - $16,000 Excess reserves = $1,000 + $16,000 - $16,000 Excess reserves = $1,000

State whether the following statement is true or false AND explain why: "A decrease in thediscount rate will always cause a decrease in the federal reserve funds rate."

It is false, the effect of a discount rate decrease on the federal funds rate depends on the level of excess reserves in the banking system. If there is a large amount of excess reserves in the system, then a discount rate decrease may not have a significant impact on the federal funds rate because banks may not need to borrow from each other to meet their reserve requirements.

The president from which federal reserve bank always has a vote in the federal open market committee?

New York

Explain and demonstrate graphically how targeting nonborrowed reserves can result in fluctuations in the federal funds rate

Research more

Explain the Fed's three tools of monetary policy and how each is used to change the money supply. Does each tool affect the monetary base or the money multiplier?

The Federal Reserve has three main tools of monetary policy: open market operations, discount rate policy, and reserve requirements. Open Market Operations: The Fed uses open market operations to buy and sell U.S. Treasury securities on the open market. When the Fed buys securities, it pays for them by increasing the reserves of banks, which in turn increases the money supply. Discount Rate Policy: When the Fed lowers the discount rate, it becomes cheaper for banks to borrow money, which encourages them to borrow more and lend more. This, in turn, increases the money supply. Reserve Requirements: When the Fed lowers reserve requirements, banks are required to hold less in reserves and can therefore lend out more money, increasing the money supply. Open market operations directly change the level of reserves in the banking system and indirectly affect the money multiplier. Discount rate policy and reserve requirements both affect bank behavior and can indirectly influence both the level of reserves and the money multiplier.

The discount rate is kept ___ the federal funds rate because the Fed prefers that ___.

above; banks borrow reserves from each other.

The discount rate is kept _____ the federal funds rate because the Fed prefers that _______.

above; banks can monitor each other for credit risk

everything else held constant, when the federal funds rate is ___ the interest paid on reserves, the quantity of reserves demanded rises when the federal funds rate ___.

above; falls

Both ________ and ________ were financial innovations that occurred because of interest rate volatility.

adjustable-rate mortgages; financial derivatives

The strongest argument for an independent Federal Reserve rests on the view that subjectingthe Fed to more political pressures would impart

an inflationary bias to monetary policy

Fluctuations in the demand for reserves cause the Fed to lose control over a monetary aggregate if the Fed targets

an interest rate

Members of the Board of Governors are

appointed by the president of the United States and confirmed by the Senate.

Duration analysis involves comparing the average duration of the bank's ________ to the average duration of its ________.

assets; liabilities

In a bank panic, the source of contagion is the

asymmetric information problem

The three players in the money supply process include

banks, depositors, and the central bank

The Fed does not tightly control the monetary base because it does NOT completely control

borrowed reserves

When financial institutions go on a lending spree and expand their lending at a rapid pace they are participating in a

credit boom

the monetary liabilities of the federal reserve include

currency in circulation and reserves

Both ________ and ________ are Federal Reserve assets.

currency in circulation; reserves

Both____ and _____ are monetary liabilities of the Fed

currency in circulation; reserves

The monetary base consists of

currency in circulations and reserves

An increase in the monetary base that goes into ___ is not multiplied, while an increase that goes into ___ is multiplied.

currency; deposits

decisions by depositors to increase their holdings of ___, or of banks to hold excess reserves will result in a ___ expansion of deposits than the simple model predicts.

currency; smaller

in the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a decline in the reserve requirement ___ the ___ curve of reserves and causes the federal funds interest rate to fall, everything else held constant.

decreases; demand

Which of the following is NOT an operating instrument?

discount rate

If the Fed injects reserves into the banking system and they are held as excess reserves, then the money supply

does not change

Competition between banks

encourages greater risk taking.

The political business cycle refers to the phenomenon that just before elections, politicians enact ___ policies. After the elections, the bad effects of these policies (for example, ___) have to be counteracted with ___ policies.

expansionary; a higher inflation rate; contractionary

Which of the following is NOT a requirement in selecting a policy instrument?

flexibility

Adjustable rate mortgages

generally have higher initial interest rates than conventional fixed-rate mortgages

Which set of goals can, at times, conflict in the short run?

high employment and price level stability

When the Fed extends a $100, 000 discount loan to the First National Bank, reserves in the banking system

increase by $100,000

When a primary dealer sells a government bond to the Federal Reserve, reserves in thebanking system ________ and the monetary base ________, everything else held constant.

increase; increase

When the Federal Reserve extends a discount to a bank, the monetary base ____ and reserves ____.

increase; increase

in the market for reserves, if the federal funds rate is above the interest rate paid on excess reserves, an open market purchase ___ the supply of reserves and causes the federal funds interest rate to ___, everything else held constant.

increases; fall

When the federal reserve extends a discount loan to a bank, the monetary base ___ and reserves ___.

increases; increase

In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, an increase in the reserve requirement ___ the demand for reserves, ___ the federal funds rate, everything else held constant

increases; raising

A nominal anchor promotes price stability by

keeping inflation expectations low

everything else held constant, in the market for reserves, when the federal funds rate is 5%, lowering the discount rate from 5% to 4% will

lower the federal funds rate

Open market purchases raise the ________ thereby raising the _______

monetary base; money supply

The goal for high employment should be a level of unemployment at which the demand forlabor equals the supply of labor. Economists call this level of unemployment the

natural rate level of unemployment

Suppose that from a new checkable deposit, First National Bank holds eight million dollars on deposit with the Federal Reserve, one million dollars in required reserves, and faces a required reserve ratio of ten percent. Given this information, we can say First National Bank has _____ million dollars in excess reserves

nine

The quantity of reserves supplied equals

nonborrowed reserves plus borrowed reserves

if the central bank targets a monetary aggregate, it is likely to lose control over the interest rate because

of fluctuations in the demand for reserves

Each governor on the Board of Governors can serve

one full nonrenewable fourteen-year term plus part of another term

Monetary policy is considered time-inconsistent because

policymakers are tempted to pursue discretionary policy that is more expansionary in the short run.

Either a dual or hierarchical mandate is acceptable as long as ________ is the primary goal in the ________.

price stability; long run

the discount rate refers to the interest rate on

primary credit

The Fed's discount lending is of three types: _____ is the most common category; _______ is given to limited number of banks in vacation and agricultural areas; _____ is given to banks that have experienced severe liquidity problems.

primary credit; seasonal credit; secondary credit

In the market for reserves, if the federal funds rate is above the interest rate paid on excess reserves, then an open market ________ the supply of reserves, raising the federal funds interest rate, everything else held constant.

purchase increases

There are two ways in which the Fed can provide additional reserves to the banking system: it can ___ government bonds or it can ___ discount loans to commercial banks.

purchase; extend

In the simple deposit expansion model, an expansion in checkable deposits of $1,000 when the required reserve ratio is equal to 10% implies that the Fed

purchased $100 in government bonds

In the simple deposit expansion model, an expansion in checkable deposits of $1,000 when the required reserve ratio is equal to 20 percent implies that the Fed

purchased $500 in government bonds

open market purchases ___ reserves and the monetary base, thereby ___ the money supply.

raise; raising

Everything else held constant, in the market for reserves, when the federal funds rate is 1%, increasing the interest rate paid on excess reserves from 1% to 2%

raises the federal funds rate

If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to

reduce the bank's assets by making fewer loans.

Rising interest-rate risk

reduce the demand for financial innovation

The monetary base minus currency in circulation equals

reserves.

The federal open market committee consists of the

seven members of the Board of Governors and five presidents of the regional Fed banks

Bruce the Bank Manager can reduce interest rate risk by ________ the duration of the bank's assets to increase their rate sensitivity or, alternatively, ________ the duration of the bank's liabilities.

shortening; lengthening

Although the FDIC was created to prevent bank failures, its existence encourages banks to

take to much risk

Which of the following is Not an entity of the Federal Reserve System?

the Comptroller of the Currency

Even if the fed could completely control the money supply, monetary policy would have critics because

the Fed is asked to achieve goals, some of which are incompatible with others.

Assume that no banks hold excess reserves, and the public holds no currency. If a bank sellsa $100 security to the Fed, explain what happens to this bank and two additional steps in thedeposit expansion process, assuming a 10% reserve requirement. How much do deposits andloans increase for the banking system when the process is completed?

the bank can now lend out $90 of the $100 it received from the Fed. This increases the total amount of checkable deposits in the banking system by $90. The borrower of the $90 checkable deposit will likely deposit the funds in another bank. Since banks must hold reserves equal to 10% of their checkable deposits, this new bank must hold $9 in required reserves and can lend out $81. This process can continue, with each new loan increasing checkable deposits in the banking system, until the total increase in checkable deposits is $1,000. Therefore, the initial increase in checkable deposits is $90, and the total increase in checkable deposits is $1,000. The total increase in loans is $900.

In the model of the money supply process, the depositor's role in influencing the money supply is represented by

the currency holdings.

critics of the current system of Fed independence contend that

the current system is undemocratic

When the federal funds rate equals the interest rate paid on excess reserves

the demand curve for reserves is vertical

An increase in the nonborrowed monetary base, everything else held constant, will cause

the money supply to rise

when the federal funds rate equals the discount rate

the supply curve of reserves is horizontal

A major controversy involving the banking industry in its early years was

whether banks should both accept deposits and make loans or whether these functions should be separated into different institutions.