Econ 331: Money and Banking Test 2 (Chapters 9,12,14,15,16)

(14.4) If the Fed buys $1 million of bonds from the First National Bank, but an additional 10% of any deposit is held as excess reserves, what is the total increase in checkable deposits? Assume that the required reserve ratio on checkable deposits is 10% and the public's holdings of currency do not change? (a) Checkable deposits increase by $5 million (b) Checkable deposits increase by $10 million (c) Checkable deposits increase by $1 million (d) Checkable deposits increase by $50 million

(a) Checkable deposits increase by $5 million [1/(.1+.1)*1 million]

(12.2) A deterioration in balance sheets of financial institutions reduces capital and causes a decline in economic activity. (a) True (b) False

(a) True

(15.2) If the Treasury has just paid a large bill to defense contractors and as a result its deposits with the Fed fall, what defensive open market operations will the manager of the open market desk undertake? (a) a defensive open market sale. (b) a repurchase agreement. (c) a defensive open market purchase. (d) none of the above are correct.

(a) a defensive open market sale.

The​ Fed's monetary policy is described as a​ "just do​ it" approach​ because: (a) it is very transparent (b) it has an official nominal anchor (c) it has an implicit nominal anchor (d) Only A and B are correct (e) all of the above are correct.

(c) it has an implicit nominal anchor

(16.8) What procedures can the fed take to control the federal funds rate? (a) inflation targeting (b) the taylor rule (c) Open market operations (d) none of the above are correct.

(c) open market operations.

(16.3) would it be problematic for a central bank to have a primary goal of maximizing economic growth? (a) No, because this could balance the economy and prevent bubbles and financial crises from occurring. (b) No, by maximizing economic growth, a central bank can effectively achieve its goal of high employment and price stability. (c) Yes, because this may result in structural changes in the economy that could lead to an increase in inflation. (d) Yes, because monetary policy has limited ability to encourage long-run economic growth other than through its ability to maintain low and stable long-run inflation and interest rates.

(d) Yes, because monetary policy has limited ability to encourage long-run economic growth other than through its ability to maintain low and stable long-run inflation and interest rates.

(16.1) Which of the following is not a benefit of using a nominal anchor for the conduct of monetary policy? (a) a nominal anchor provides a direct measure to see if the central bank is achieving its goal. (b) a nominal anchor helps promote price stability by trying inflation expectations to low levels directly through its constraint on the value of money. (c) a nominal anchor can limit the time-inconsistency problem by providing an expected constraint on monetary policy. (d) a nominal anchor creates a rigid rule that does not allow a central bank to adjust to unforeseen circumstances.

(d) a nominal anchor creates a rigid rule that does not allow a central bank to adjust to unforeseen circumstances.

(16.8) When comparing the monetary base to M1 on the grounds of controllability and mesurability, why would you prefer the monetary base as an intermediate target? (a) the monetary base is measured more accurately and quickly. (b) the fed can calculate data on the monetary base form its own balance sheet data, while it constructs M1 numbers from surveys of banks, which take some time to collect and are not always that accurate. (c) the monetary base is more directly influenced by the tools of the fed. (d) all of the above are correct.

(d) all of the above are correct

(15.2) Why are repurchase agreements used to conduct most short-term monetary policy operations, rather than simply buying and selling securities outright? (a) repurchase agreements are temporary open market purchases that can be reversed. (b) Repurchase agreements allow the fed to easily adjust open market operations in response to daily conditions. (c) they are effective in dealing with persistent shortage in reserves, and thus have a more permanent impact. (d) only A and B are correct. (e) all of the above are correct.

(d) only A and B are correct.

(12.3) Why is the shadow banking system an important part of the 2007-2009 financial crisis? (a) An increase of funding from the shadow banking system resulted in a decrease in the issuance of CDOs, increasing the severity of adverse selection and moral hazard problems. (b) A decrease of funding from the shadow banking system caused a restriction of lending and a decline in economic activity. (c) The shadow banking system was able to take on significantly less risk than other financial firms, prevention the economy from losses. (d) A large amount of funds flowed through the shadow banking system, which increased interest rates and fueled some of the housing bubble.

(b) A decrease of funding from the shadow banking system caused a restriction of lending and a decline in economic activity.

(14.4) If a bank depositor withdraws $1,000 of currency from an account, what happens to reserves, checkable deposits, and the monetary base? Assume that the required reserve ratio on checkable deposits is 10% and banks do not hold any excess reserves. (a) Reserves do not change, checkable deposits fall by $10,000 and the monetary base falls by $1,000. (b) Reserves fall by $1,000, checkable deposits fall by $10,000, and the monetary base remains unchanged. (c) Reserves do not change, checkable deposits fall by $1,000, and the monetary base falls by $10,000 (d) Reserves fall by $10,000, checkable deposits fall by $1,000, and the monetary base remains unchanged.

(b) Reserves fall by $1,000, checkable deposits fall by $10,000, and the monetary base remains unchanged.

(14.7) "The money multiplier is necessarily greater than 1." Is this statement true or false? (a) True, because in reality, the required and excess reserves ratios generally add up to more than one. (b) True, because in reality, the required and excess reserves ratios typically add up to less than one. (c) True, because in reality, the required and excess reserves ratios usually add up to one. (d) False, because economic data show that the money multiplier is always less than one.

(b) True, because in reality, the required and excess reserves ratios typically add up to less than one.

(15.2) If the manager of the open market desk hears that a snowstorm is about to strike New York City, making it difficult to present checks for payment there and so raising the float, what defensive open market operations will the manager undertake? (a) a repurchase agreement. (b) a defensive open market sale (c) a defensive open market purchase. (d) none of the above are correct.

(b) a defensive open market sale

(15.2) Which of the following is a cost of fed discount operations> (a) banks have to pay back the discount loans at the discount rate, which costs money. (b) banks that deserve to go out of business due to poor management may survive because of fed discounting to prevent bank panics. (c) the fed has to pick and choose which banks receive discount loans, which banks dislike. (d) there are no costs to discount operations because the discount loans have to be paid back.

(b) banks that deserve to go out of business due to poor management may survive because of fed discounting to prevent bank panics.

(16.7) According to eh Greenspan Doctrine, a central bank can respond to a perceived stock market bubble by: (a) influencing asset prices in general rather than specific assets. (b) not acting directly on the bubble, but pursuing a normal policy to maintain price stability in real economic activity. (c) decreasing interest rates in order to maintain price stability. (d) reducing the size of the bubble preemptively so that it results in less damage than cleaning after the bubble crash.

(b) not acting directly on the bubble, but pursuing a normal policy to maintain price stability in real economic activity.

(15.1) A decrease in the discount rate does not normally lead to an increase in borrowed reserves because: (a) there is often a time lag between a decrease in the discount rate and the market reaction to it. (b) the equilibrium interest rate will still fall below the discount rate. (c) a decrease in the discount rate usually leads to an increase in nonborrowed reserves. (d)setting the disount rate below the equilibrium rate is forbidden by law, since a clear arbitrage opportunity would exist.

(b) the equilibrium interest rate will still fall below the discount rate.

(12.3) Housing prices boomed from 2002 to 2006, and then prices started to decline in 2006, falling by more than 30%, which led to defaults by subprime mortgage holders. Effect A: Subprime borrowers found the value of the house fell below the amount of the mortgage. B: Defaults on houses declined during this period. C: Banks began to restrict the availability of credit to households. Which of the effects listed above may have helped trigger the subprime financial crisis starting in 2007? (a) B and C (b) A and B (c) A and C. (d) A, B, and C

(c) A and C.

(9.3) If a bank doubles the amount of its capital and ROA stays constant, what will happen to ROE? (a) Given the ROA, if bank capital doubles, the ROE will fall by half. (b) Given the ROA, if bank capital doubles, then ROE will also double. (c) Even if the bank doubles its amount of capital, if ROA is constant, then ROE will remail unchanged. (d) The effect on ROE cannot be determined based on the information provided.

(a) Given the ROA, if bank capital doubles, the ROE will fall by half.

(9.5) Suppose that you are the manager of a bank whose $100 billion of assets have an average duration of four years and whose $90 billion of liabilities have an average duration of six years. Conduct a duration analysis for the bank, and show what will happen to the net worth of the bank if interest rates rise by 2 percentage points. Assets fall in value by $_____billion. Liabilities fall in value by $____billion. Net worth (increases/decreases) by $_____ billion.

Change in asset value = ($100 billion * -.02 * 4) = $8 billion. Change in liability value = ($90 billion * -.02 * 6) = $10.8 billion. Change in net worth = change in assets - change in liabilites = -8 billion - (-10.8 billion) = 2.8 billion. So, net worth increases by $2.8 billion.

(9.3) Victory Bank reports an EM (equity multiplier) of 20 while Batovi Bank reports an EM equal to 12. The equity capital as a percentage of assets for Victory Bank is ___% and for Batovi Bank is _____%. Which bank is better prepared to respond against large losses on loans? (a) Batovi Bank because it has a lower equity capital than Victory Bank. (b) Victory Bank because it has a lower equity capital than Batovi Bank. (c) Victory bank because it has a higher equity capital than Batovi Bank. (d) Batovi Bank because it has a higher equity capital than Victory Bank.

Equity capital =​ [1 / EM​ × 100]. Victory Bank = 5% Batovi Bank = 8.33% (d) Batovi Bank because it has a higher equity capital than Victory Bank.

(12.2) Deposit insurance prevents financial crises. Is this statement always true? Which of the following statements support your answer? (Select all that apply) (a) Deposit insurance increases information asymmetry between banks and borrowers. (b) Deposit insurance creates moral hazard incentives encouraging risk taking on the part of banks. (c) Deposit insurance is unable to prevent the fire sales resulting from a run on the shadow banking system. (d) Deposit insurance is unable to prevent the effects of an asset price decline or the spread of a financial crisis to international financial markets.

No. (Deposit insurance is a very good system to prevent bank​ panics, but these events are just one potential element in a financial crisis.) (b) Deposit insurance creates moral hazard incentives encouraging risk taking on the part of banks. (d) Deposit insurance is unable to prevent the effects of an asset price decline or the spread of a financial crisis to international financial markets.

(14.7) In October 2008, the Federal Reserve began paying interest on the amount of excess reserves held by banks. How, if at all, might this affect the multiplier process and the money supply? Holding the monetary base constant, paying interest on reserves should (reduce/not change/raise) the excess reserves ratio, which (reduces/does not change/raises) the money multiplier and (raises/does not change/reduces) the money supply.

Raise Reduces Reduces

(9.3) Angus Bank holds no excess reserves but complies with the reserve requirement. The required reserves ratio is 9% and reserves are currently $27 million. The amount of deposits is $ ____ million. The reserve shortage created by deposit outflow of $5 million is $____ million. The cost of the reserve shortage if Angus Bank borrows from the federal funds market (assume the federal funds rate is 0.25%) is $_______

The amount of deposits can be calculated by dividing current reserves by the required reserves ratio. The amount of deposits is $300 million. The reserve shortage is calculated by subtracting the required reserves after the deposit outflow from the outstanding reserves after the deposit outflow. Reserve shortage = 22 - 295 * (9/100) = $-4.55 million. The cost of the reserve shortage is the product of the reserve shortage and the federal funds rate. Angus​ Bank's cost of borrowing from the Fed​ = ​(0.25​/100) ​× 4.55 ​= 0.0025 ​× ​$4.55 million​ = ​$11,375.

(credit-drivin/noncredit drivin) bubbles can be far more devastating to the economy if a crash occurs than if policymakers acted to reduce the size of the bubble preemptively. On the other hand, (noncredit-drivin/credit drivin) bubbles can be dealth with more easily after a crash. Therefore it would be better to (lean against/clean after) credit-drivin bubbles and (clean after/lean against) other types of asset bubbles crash.

credit driven noncredit driven lean against clean after

(16.4) "Because inflation targeting focuses on achieving the inflation target, it will lead to excessive output fluctuations." is this statement true, false or uncertain. A common fear of inflation targeting is that it will lead to excessive output fluctuations. This fear is overstated because inflation targeting (does not require/requires) a sole focus on inflation. In practice, inflation targeters may (be able to reduce/create additional) output fluctuations since inflation targeting allows monetary policymakers to respond to declines in demand without facing a sharp rise in inflation expectations. Inflation targeting (does not/tends to) ignore traditional stabilization goals. Inflation targeters typically use (an exact percentage/a percentage range) for an inflation-rate target.

does not require be able to reduce does not a percentage range

(12.3) Which of the following did not help prevent the financial crisis of 2007-2009 from becoming a depression? (a) The Federal Reserve's use of monetary policy to lower the federal funds rate target. (b) The purchase of stock and ownership takeovers of troubled banks by the Federal Reserve. (c) The use of nonconventional policy by the Federal Reserve to create term auction facilities. (d) The creation of new programs, such as lending to investment banks and purchasing commercial paper, by the Federal Reserve.

(b) The purchase of stock and ownership takeovers of troubled banks by the Federal Reserve.

(12.2) Why do credit spreads rise during financial crises? (a) Credit spreads rise because the government becomes the only institution that is able to lend money to borrowers. (b) Credit spread rises because depositors with productive investment opportunities withdraw their funds from banks, which creates an incentive to lend to borrowers with riskier investment opportunities. (c) Credit spreads rise because asymmetric information problems increase, making it more difficult to judge the risk of potential borrowers. (d) None of the above are correct.

(c) Credit spreads rise because asymmetric information problems increase, making it more difficult to judge the risk of potential borrowers.

(9.2) What happens to reserves at the First National Bank if one person withdraws $900 of cash and another person deposits $600 of case?

First National Bank: Reserves: $-300 Checkable deposits: $-300

(9.6) After July 2010, bank customers using a debit card had to specifically opt-in to the bank's overdraft protection plan. Which of the following is an effect of this regulation on bank's noninterest income? (a) As many customers do not opt-in, noninterest income has decreased. (b) As many customers are automatically enrolled in bank's overdraft protection plans, noninterest income has increased.

(a) As many customers do not opt-in, noninterest income has decreased.

(15.2) __________ are intended to change the level of reserves and the monetary base. (a) dynamic open market operations. (b) open market purchases. (c) defensive open market operations. (d) open market sales.

(a) dynamic open market operations.

(15.3) In early 2016, as the Bank of Japan began to push policy interest rates towards negative, there was a sharp increase in sales of home safes in Japan. Which of the following are likely to be the effects of a negative interest rate policy? (select all that apply) (a) it can stimulate the economy by increasing consumption and borrowing and penalizing saving in the form of deposits. (b) it can destabilize the banking system, decrease liquidity in the banking system, and reduce the amount of money available for lending in the banking system. (c) it can reduce economic growth if depositors pull their deposits out of banks and instead hold them as cash in safes. (d) it can reduce economic growth if all depositors pull their deposits out of banks as it is likely to cause Japanese yen to depreciate.

(a) it can stimulate the economy by increasing consumption and borrowing and penalizing saving in the form of deposits. (b) it can destabilize the banking system, decrease liquidity in the banking system, and reduce the amount of money available for lending in the banking system.

(15.2) Because most open market operations are typically repurchase agreements, it is likely that the volume of defensive open market operations is (the same as/less than/greater than) the volume of dynamic open market operations.

greater than

(9.3) Why do equity holders care more about ROE than about ROA? (a) A higher ROE indicates a higher level of liquidity for the investment, while a higher ROA does not. (b) ROE measures how efficiently the bank is being run, while ROA measures how much equity holders are earning. (c) A changing in ROE indicates a change in the safety of the investment, while a change in ROA does not. (d) ROE measures how much equity holders are earning, while ROA measures how efficiently the bank is being run.

(ROE is the net profit after taxes per dollar of equity​ capital, while ROA equals net profit after taxes per dollar of assets.) (d) ROE measures how much equity holders are earning, while ROA measures how efficiently the bank is being run.

(14.4) The First National Bank receives and extra $100 of reserves but decides not to lend any of these reserves. How much deposit creation takes place for the entire banking system? (a) $0 (b) $100 (c) $1,000 (d) There is not enough information provided to determine the answer.

(a) $0

(12.2) What is a credit spread? (a) The difference between interest rates on loans to households and businesses and interest rates completely safe assets such as U.S. Treasury Bills. (b) The difference between a borrower's credit score and the score of the most credit-worthy borrower. (c) The difference between the interest rates on corporate bonds with different maturities. (d) The difference between the net worth of a borrower and the amount of the loan the borrower would like to secure.

(a) The difference between interest rates on loans to households and businesses and interest rates completely safe assets such as U.S. Treasury Bills.

(15.2) "Discount loans are no longer needed because the presence of the FDIC eliminates the possibility of bank panics." Why is this statement false? (a) the fed uses discounting to keep bank failures from spreading. (b) the fed uses open market operations to inject liquidity. (c) the fed can change the reserve requirements. (d) all of the above explain why the statement is incorrect.

(a) the fed uses discounting to keep bank failures from spreading.

(15.2) Now identify the policy tools that have the least: Flexibility (changes in the reserve requirement/open market operations/loans to financial institutions) reversibility (changes in the reserve requirement/open market operations/loans to financial institutions) speed of implementation (changes in the reserve requirement/open market operations/loans to financial institutions) effectiveness (changes in the reserve requirement/open market operations/loans to financial institutions)

Changes in reserve requirements Changes in reserve requirements Changes in reserve requirements Loans and financial institutions.

(16.8) How can forward guidance as a tool of the central bank impact the policy instrument, intermediate targets, and goals? (select all that apply) (a) The central bank can communicate the expected path of its asset holdings. This impacts the expected reserve aggregates which can then impact intermediate targets. (b) The central bank can communicate information about the expected path of future​ short-term interest rates. This can affect intermediate targets such as​ longer-term interest rates. (c)The central bank can change the reserves requirements for commercial banks. This can affect economic​ activity, and ultimately other related goals such as price or exchange rate stability. (d) The central bank can​ expand/contract the monetary base. This can affect economic​ activity, and ultimately other related goals such as price or exchange rate stability.

(a) The central bank can communicate the expected path of its asset holdings. This impacts the expected reserve aggregates which can then impact intermediate targets. (b) The central bank can communicate information about the expected path of future​ short-term interest rates. This can affect intermediate targets such as​ longer-term interest rates.

(16.5) Which of the following is not an advantage of the monetary strategy used at the Federal Reserve under Alan Greenspan and Ben Bernanke in which the nominal anchor is only implicit? (a) it has a lack of transparency. (b) it does not rely on a stable money-inflation relationship. (c) in enables monetary policy to focus on domestic considerations. (d) all of the above are advantages.

(a) it has a lack of transparency.

(16.5) which of the following is a disadvantage of the monetary strategy used at the Federal Reserve under Alan Greenspan and Ben Bernanke in which the nominal anchor is only implicit? (a) it is dependent on the preferences, skills, and trustworthiness of individuals in the central bank and the government. (b) It forces the Federal Reserve to focus on foreign considerations rather than domestic. (c) It does not rely on a stable money-inflation relationship. (d) all of the above are disadvantages.

(a) it is dependent on the preferences, skills, and trustworthiness of the individuals in the central bank and the government.

(16.8) Why does control of this interest rate imply that the Fed will lose control of nonborrowed reserves? (a) the fed has to adjust reserves in response to changes in reserve demand to keep interest rates at the target. (b) the fed lacks control over both the nominal and real interest rates, so it cannot control everything. (c) the fed has to change the amount of discount loans it makes when it sets an interest-rate target. (d) all of the above are correct.

(a) the fed has to adjust reserves in response to changes in reserve demand to keep interest rates at the target.

(16.4) Why might inflation targeting increase support for the independence of central bank to conduct monetary policy? (a) An inflation target requires that the monetary authorities use just one variable to determine the best settings for monetary policy. (b) An explicit numerical inflation target increases the accountability of the central bank and may reduce the likelihood that the central bank will try to expand output and employment in the short run by pursuing overly expansionary monetary policy. (c) Inflation targeting is not well understood by the public and is highly obscure; therefore, it is better to be left to an independent central bank. (d) Only A and B are correct. (e) All of the above are correct.

(b) An explicit numerical inflation target increases the accountability of the central bank and may reduce the likelihood that the central bank will try to expand output and employment in the short run by pursuing overly expansionary monetary policy.

(15.3) What could happen if no good investment opportunities exist? (a) The funds might get channeled into the housing market and deflate house prices. (b) Banks might not lend out their deposits at the central bank, but instead move them into cash. (c)Both A and B.

(b) Banks might not lend out their deposits at the central bank, but instead move them into cash.

(9.4) "Because diversification is a desirable strategy for avoiding risk, it never makes sense for a bank to specialize in making specific types of loans." Is this statement true of false? Explain your answer. (a) False. A bank does not gain anything by diversifying; the bank only raises its costs when it diversifies. (b) False. A bank may have developed expertise in screening and monitoring a particular type of loan, thus improving its ability to handle problems of adverse selection and moral hazard. (c) True. Diversification is a desirable strategy for a bank, so it does not make sense for a bank to specialize in certain types of lending. (d) True. A bank can reduce its risk by diversifying, just like individuals can.

(b) False. A bank may have developed expertise in screening and monitoring a particular type of loan, thus improving its ability to handle problems of adverse selection and moral hazard.

(16.8) "If the demand for reserves did not fluctuate, the Fed could pursue both a reserves target and an interest-rate target at the same time." Is this statement true, false, or uncertain? explain your answer. (a) True. the nominal interest rate and the real interest rate would have to be the same. (b) True. The target interest rate would have a set level of reserves that would only change if the Fed desired. (c) False. A reserves target and interest-rate target can never have the same policy outcome. (d) Uncertain. There is not enough information about how the interest rate would be set.

(b) True. The target interest rate would have a set level of reserves that would only change if the Fed desired.

(16.8) "Interest rates can be measured more accurately and quickly than reserve aggregates; hence an interest rate is preferred to the reserve aggregates as a policy instrument." do you agree or disagree. (a) disagree. nominal interest rates are measured more accurately and quickly than the money supply; therefore, interest-rate targets are not necessarily better than money-supply targets. (b) disagree. the measurement of real interest rates requires estimates of expected inflation, and it is not true that real interest rates are necessarily measured more accurately and quickly than the money supply. (c) Agree. policymakers care only about nominal interest rates when making policy decisions and do not use the money supply of its aggregates in making decisions. (d) Agree. although nominal interest rates are measured more accurately and quickly than the money supply, the interest rate variable that is of more concern to policymakers is the real interest rate.

(b) disagree. the measurement of real interest rates requires estimates of expected inflation, and it is not true that real interest rates are necessarily measured more accurately and quickly than the money supply.

(16.4) Why is a public announcement of numerical inflation rate objectives important to the success of an inflation-targeting central bank? (a) it allows market participants to influence the inflation rate. (b) it reduces uncertainty in inflation expectations of market participants. (c) It reduces the costs of high inflation to society. (d) It imposes a rigid rule on monetary policymakers and thus limits any change in policy actions.

(b) it reduces uncertainty in inflation expectations of market participants.

(16.4) Does inflation targeting help reduce the time-inconsistency of discretionary policy? (a) Yes, it decreases the transparency of monetary policy strategy and hence the public's expectations of inflation. (b) No, inflation targeting decreases the accountability of monetary policymakers. (c) Yes, it is a mechanism of self-discipline, which effectively ties the hands of policymakers to commit to a policy path. (d) No, there is no direct relationship between inflation targeting and solving time-inconsistency problem.

(c) Yes, it is a mechanism of self-discipline, which effectively ties the hands of policymakers to commit to a policy path.

(16.3) "A central bank with a duel mandate will achieve lower unemployment in the long run than a central bank with a hierarchical mandate in which price stability takes precedence." Is this statement true of false? Explain your answer. (a) False. Inflation targeting still allows central banks to constantly adjust for unemployment concerns. (b) True. The short-run Phillips curve shows an inverse relationship between inflation and unemployment. (c) True. Inflation targeting only allows a central bank to focus on inflation. (d) False. There is no long-run trade-off between inflation and unemployment.

(d) False. There is no long-run trade-off between inflation and unemployment.

(16.3) "Since financial crises can impart severe damage to the economy, a central bank's primary goal should be to ensure stability in financial markets." Is this statement true, false, or uncertain? Explain you answer. (a) False. Price stability should always be the primary goal of any central market. (b) True. If financial market stability had been pursued, the 2007-2009 recession would have been prevented. (c) True. If financial market stability is maintained, then funds are channeled to the most productive investment opportunities, thus leading to an expansion in economic activity. (d) Uncertain. Although stability in financial markets is an important goal, focusing on other goals such as stabilizing employment, output, or even short-term movements in the business cycle may be more important to the economy.

(d) Uncertain. Although stability in financial markets is an important goal, focusing on other goals such as stabilizing employment, output, or even short-term movements in the business cycle may be more important to the economy.

(16.7) Which of the following explains why macro-prudential regulation is more effective in managing asset-price bubbles than is monetary policy? (a) many different asset prices exist, and at any one time a bubble may be present in only a fraction of asset markets. monetary policy actions are a very blunt instrument in such a case. (b) monetary policy actions to prick bubbles can have harmful effects on the aggregate economy. (c) macroprudential regulation include polciy to affect only what is happening in credit markets and is thus the right tool for reining in credit-drivin asset-price bubbles. it is much easier to identify credit booms than asset-price bubbles. (d) all of the above

(d) all of the above.

Credit-driven bubbles are _______ to identify and pose a ______ threat to the financial system compared to bubbles driven soley by irrational exuberance. (a) harder, larger (b) easier, smaller (c) harder, smaller (d) easier, larger

(d) easier, larger

(16.4) What methods have inflation-targeting central banks used to increase communication with the public and increase the transparency of monetary policy making? (a) Inflation-targeting central banks have used brochures with fancy graphics,boxes, and other eye-catching design elements to engage the public's interest. (b) Inflation-targeting central banks have frequent communications with the government. (c) Inflation-targeting central banks take the opportunity to make public speeches on their monetary policy strategy. (d) Only B and C are correct. (e) All of the above are correct.

(e) all of the above are correct.

(14.3) If the Fed sells $2 million of bonds to the First National Bank, what happens to reserves and the monetary base? complete the T-Accounts below to explain your answer. Reserves ______________ and the monetary base ___________________.

First National Bank Assets: Reserves -$2million Securities $2million Liabilities: Federal Reserve System Assets: Securities -$2million Liabilities: Reserves -$2million Reserves fall by $2 million and the monetary base falls by $2 million.

(9.2) Using the T-accounts of the First National Bank and the Second National Bank, describe what happens when Jane Brown writes a check for $65 on her account at the First National Bank to pay her friend Joe Green, who in turn deposits the check in his account at the second national bank.

First National Bank: Reserves: $-65 Checkable deposits: $-65 Second National Bank: Reserves: $65 Checkable deposits: $65

If the Fed sells $2 million of bonds to Irving the Investor, who pays for the bonds with a briefcase filled with currency, what happens to reserves and the monetary base? Use T-accounts to explain your answer. Reserves ____________ and the monetary base ________________

Irving the Investor Assets: Currency -$2million Securities $2million Liabilities: Federal Reserve System Assets: Securities -$2million Liabilities: Currency -$2million Reserves remain unchanged, and the monetary base falls by $2 million.

(9.3) Excess reserves act as insurance against deposit outflows. Suppose that on a yearly basis, Malcom Bank holds $12 million in excess reserves and $88 million in required reserves. Malcom Bank can earn an interest of 3.50% on its loans and that the interest paid on (total) reserves is 0.2% What would be the cost of this insurance policy? The cost of this insurance policy is $_____ million

The cost of the insurance policy is the amount of the foregone interest income minus the interest paid on excess reserves. Foregone Interest Income​ = ​$12 ​× ​(3.50​/100) ​= ​$0.42 million. Interest Paid on Excess Reserves​ = 12 ​× ​(0.2​/100) ​= ​$0.024 million. $0.396 million.

(16.8) Classify each of the following as either a policy instrument or an intermediate target, and explain why. The ten-year Treasury bond rate is (a policy instrument/ an intermediate target) because it (is not/is) affected by the Fed's monetary policy tool and (has/does not have) a direct effect on economic activity. The monetary base is (a policy instrument/ an intermediate target) because it (is not/is) affected by the Fed's monetary policy tools and(has/does not have) a direct effect on economic activity. M1 is (a policy intermediate/an intermediate target) because it (is/ is not) affected by the Fed's monetary policy tools and (has/does not have) a direct effect on economic activity. the fed funds rate is (an intermediate target/a policy instrument) because it (can/cannot) be directly affected by the tools of the fed.

an intermediate target is has a policy instrument is does not have an intermediate target is not has policy instrument can

(14.3) Classify the following transaction as affecting either assets, a liabilities, or neither for each of the "players' in the money supply process -- the Federal Reserve, banks, and depositors. The Fed provides an emergency loan to a bank for $1,000,000. (a) Assets and liabilities of the banking system as a whole are unaffected, however, individual bank balance sheets will change. (b) Depositors: Assets rise and are offset by a fall in assets due to lower checking account balances. Banks: Reserves assets decrease and checkable deposit liabilities decrease. (c) Banks: Assets and liabilities increase. Fed: Assets and liabilities increase. (d) Depositors: Assets rise and liabilities rise. Banks: Assets rise, but this is offset by a decrease in reserve assets.

c) Banks: Assets and liabilities increase. Fed: Assets and liabilities increase.

(16.9) If potential output declines while actual output remains unchanged, what does the Taylor rule imply that policymakers should do to the fed funds rate? Based on this scenario, policy makers should (not change/decrease/increase) the fed funds rate because: (a) the output gap would increase (b) the output gap would decrease. (c) the rate of actual output growth would decline. (d) changes in potential output do not influence the fed funds rate.

increase (a) the output gap would increase.

(14.7) Following the financial crisis in​ 2008, the Federal Reserve began injecting the banking system with massive amounts of​ liquidity, and at the same​ time, very little lending occurred. As a​ result, the M1 money multiplier was below 1 for most of the time from October 2008 through 2011. How does this relate to your answer to the previous​ step? (a) If large amounts of reserves enter the banking system but are held as excess​ reserves, it is possible for the money multiplier to fall below one. (b) If the central bank injects the banking system with massive amounts of​ liquidity, the money multiplier always falls below one. (c) If large amounts of reserves enter the banking system but are held as excess​ reserves, the money multiplier tends to rise above one. d) The amount of excess reserves held does not affect the value of the money multiplier.

(a) If large amounts of reserves enter the banking system but are held as excess​ reserves, it is possible for the money multiplier to fall below one.

(9.3) If a bank is falling short of meeting its capital requirements by $1 million, what three things can it do to rectify the situation? (check all that apply) (a) Issue Stock (b) Call in existing loans in an attempt to decrease its asset holdings. (c) Borrow from other banks or corporations. (d) Decrease dividend payments to increase retained earnings.

(a) Issue stock (b) Call in existing loans in an attempt to decease its asset holdings (d) Decrease dividend payments to increase retained earnings.

(15.2) You often read in the newspaper that the Fed has just lowered the discount rate. Does this signal that the Fed is moving to a more expansionary monetary policy? why or why not? (a) No. The Fed usually lowers the discount rate when market rates fall regardless of the direction of monetary policy. (b) Yes. The fed usually uses the discount rate to manipulate the money supply. (c) Yes. The Fed usually uses the discount rate to signal future of monetary policy. (d) No. The fed usually lowers the discount rate to signal contractionary policy.

(a) No. The Fed usually lowers the discount rate when market rates fall regardless of the direction of monetary policy.

(9.3) If the bank you won has no excess reserves and a sound customer comes in asking for a loan, should you automatically turn the customer down, explaining that you don't have any excess reserves to lend out? Why or why not? What options are available to you to provide the funds your customer needs? (a) No. There are several way reserves can be acquired. For example, the bank can borrow at the discount window of the federal funds market, or it can acquire funds by issuing negotiable CDs. (b) Yes. In response to the subprime mortgage meltdown, the Federal Lending Act of 2008 stipulates that excess reserves are the only source of new lending. (c) Yes. Although excess reserves are not the only source of new lending, the cost of acquiring the excess reserves for lending are higher than the expected return on the loan. (d) No. there are only two sources of funds that can be used to acquire reserves. The bank can borrow at the discount window or in the federal funds market.

(a) No. There are several way reserves can be acquired. For example, the bank can borrow at the discount window of the federal funds market, or it can acquire funds by issuing negotiable CDs.

(14.5) If the central bank sells 1 million of bonds and banks reduce their borrowings from the central bank by 1 million, predict what will happen to the money supply. (a) The monetary base would fall by 2 million, leading to a decline in the money supply (b) The sale of bonds would offset the reduction in borrowings so there would be no change in the monetary base and money supply (c) The monetary base would rise by 2 million, leading to an increase in the money supply (d) The effect on the money supply is ambiguous.

(a) The monetary base would fall by 2 million, leading to a decline in the money supply

(14.5) The Fed buys $100 million of bonds from the public and also lowers the reserve requirement r. What will happen to the money supply? (a) The money supply will increase. (b) The money supply will not change. (c) The money supply will decrease. (d) The effect on the money supply is ambiguous.

(a) The money supply will increase.

(9.3) Which of the following is a cost for a bank when it decides to increase the amount of its bank capital? (a) The return on equity decreases. (b) The return on assets decreases. (c) The liquidity of its loans and other assets falls. (d) The safety of its loans decreases.

(a) The return on equity decreases.

(12.3) Identify the differences between the United States' experiences during the Great Depression and the financial crisis of 2007-2009. (Check all that apply). (a) The source of asset - price increases was different for both episodes. (b) Unemployment was a larger factor during the recent financial crisis with only minor implications during the Great Depression. (c) No bank panic occurred in 2007-2009 as opposed to the Great Depression. (d) The banking system was not hit as hard during the Great Depression as it was during the 2007-2009 financial crisis. (e) The recent crisis resulted in more significant declines in GDP than the Great Depression.

(a) The source of asset - price increases was different for both episodes. (c) No bank panic occurred in 2007-2009 as opposed to the Great Depression.

(12.3) Advances in computer technology and new statistical techniques led to the development of subprime mortgages. (a) True (b) False

(a) True

(15.1) "The federal funds rate can sometimes be below the interest rate paid on reserves." Is this statement true, false, or uncertain? Explain your answer. (a) True. This may happen because nonbank financial institutions, which cannot earn interest on reserves, participate in the federal funds market. (b)False. Banks would prefer earning a risk-free interest rate rather than loaning excess reserves in the more risky federal funds market at an equivalent or lower rate. (c) Uncertain. It depends on the stigma associated for banks to borrow directly from the Fed.

(a) True. This may happen because nonbank financial institutions, which cannot earn interest on reserves, participate in the federal funds market.

(15.2) During the holiday season when the public's holdings of currency increase, what defensive open market operations typically occur? (a) A defensive open market purchase. (b) a matched sale-purchase transaction. (c) a defensive open market sale. (d) none of the above are correct.

(a) a defensive open market purchase.

(15.2) ___________ are intended to offset movements in other factors that affect reserves and the monetary base. (a) defensive open market operations (b) open market purchases (c) open market sales (d) dynamic open market operations.

(a) defensive open market operations.

(15.3) What is the main advantage of an unconditional policy commitment? (a) it provides a significant amount of certainty, which makes it easier for markets and households to make decisions about the future. (b) not strictly maintaining the commitment could be viewed as reneging on a promise, and the central bank could lose significant credibility. (c) if conditions suddenly change where a change in the policy stance may be warranted, unconditional policy commitment allows for such flexibility.

(a) it provides a significant amount of certainty, which makes it easier for markets and households to make decisions about the future.

(15.3) In which economic conditions would a central bank want to use a "forward-guidance" strategy? (a)when all the conventional tools of monetary policy have failed to affect the economy in the desired way. (b) when open market operations have failed to affect the economy in the desired way. (c) when discount policy cannot be used by the Fed to perform its role as lender of last resort. (d) When the Fed wants to raise interest rates after banks have accumulated large amounts of excess reserves.

(a) when all the conventional tools of monetary policy have failed to affect the economy in the desired way.

(12.3) Some countries do not advertise that a system of deposit insurance like the FDIC (The Federal Deposit Insurance Corporation) in the United States exists in their banking system. Which of the following explain why some counties do not advertise that a system of deposit insurance exists in their banking system? (Select all that apply) (a)Not advertising deposit insurance may reduce the problem of moral hazard, which is created by a system of deposit insurance. (b) The information about the presence of a system of insurance makes depositors and bank clients less likely to monitor a bank's activities. (c) The disclosing of information about the presence of a system of deposit insurance restricts bank from engaging in hedge fund trading with derivatives. (d) Not advertising deposit insurance may increase the problem of adverse selection between lenders and potential depositors.

(a)Not advertising deposit insurance may reduce the problem of moral hazard, which is created by a system of deposit insurance. (b) The information about the presence of a system of insurance makes depositors and bank clients less likely to monitor a bank's activities.

(9.3) Why might a bank be willing to borrow funds from other banks at a higher rate rather than borrow from the Fed? (a) Other banks are willing to lend reserves for free within the banking community (b) Borrowing from the Fed might invite greater supervisory scrutiny from the central bank. (c) The Fed charges a lending rate much higher than market rates. (d) Non-member banks can only borrow from the Fed by paying additional loan origination fees.

(b) Borrowing from the Fed might invite greater supervisory scrutiny from the central bank.

(14.4) What happens to checkable deposits in the banking system when the Fed lends an additional $1 million to the First National Bank, assuming that the required reserve ratio on checkable deposits is 10%, banks do not hold any excess reserves, and the public's holdings of currency do not change? (a) Checkable deposits rise by $100,000 (b) Checkable deposits rise by $10 million (c) Checkable deposits rise by $1 million (d) Checkable deposits rise by $900,000

(b) Checkable deposits rise by $10 million

(12.2) "A general increase in uncertainty as a result of a failure of a major financial institution makes it easier to separate good credit from bad credit, which can lead to a reduction in adverse selection and moral hazard problems." is this statement true or false? (a) Tue (b) False

(b) False.

(9.5) "Bank managers should always seek the highest return possible on their assets." Is this statement true, false, or uncertain? (a) True. Seeking the highest return possible will always prevent a bank failure. (b) False. A bank must also consider an asset's risk and liquidity when deciding which assets to hold. (c) True. The highest return possible on assets will guarantee the highest income for the bank. (d) Uncertain. This statement is true only in the bank has more rate-sensitive liabilities than assets.

(b) False. A bank must also consider an asset's risk and liquidity when deciding which assets to hold.

(14.3) "The Fed can perfectly control the amount of reserves in the system." Is this statement true, false, or uncertain? Explain your answer. (a) True. because the Fed sets the required reserve ration for banks, it effectively has control over the amount of reserves in the banking system. (b) False. A shift from deposits to currency will affect the amount of reserves, and since other players are involved in this process, the Fed ultimately cannot control the level of reserves in the system. (c) True. The Fed is able to effectively control the monetary base and the amount of reserves through open market operations. (d) Uncertain. The amount of control the Fed has over reserves is variable, as it often depends on current economic conditions.

(b) False. A shift from deposits to currency will affect the amount of reserves, and since other players are involved in this process, the Fed ultimately cannot control the level of reserves in the system.

(14.3) "The Fed can perfectly control the amount of the monetary base, but has less control over the composition of the monetary base." Is this statement true, false, or uncertain? Explain your answer. (a) True. By controlling the discount rate, the Fed is able to accurately predict banks' borrowings from the Fed, which allows the Fed to control the amount of reserves in the banking system and hence the monetary base. (b) False. Since the Fed cannot control the amount of discount lending to financial institutions id does not have perfect control over the amount of reserves in the banking system and hence the monetary base. (c) True. Because the Fed can alter the monetary base through its open market operations, it effectively gives the Fed perfect control of the monetary base. (d) Uncertain. Perfect control of the monetary base is only guaranteed if MBn = MB-BR.

(b) False. Since the Fed cannot control the amount of discount lending to financial institutions id does not have perfect control over the amount of reserves in the banking system and hence the monetary base.

(12.1) Which of the following statements is true of financial frictions? (a) Financial frictions are a set of conditions that prevents financial markets from undertaking high-risk investment. (b) Financial frictions are a set of conditions that prevents financial markets from effectively assigning funds to the best investment opportunities. (c) Financial frictions help avoid the problem of adverse selection in financial markets. (d) Financial frictions help avoid the problem of moral hazard in financial markets.

(b) Financial frictions are a set of conditions that prevents financial markets from effectively assigning funds to the best investment opportunities.

(12.3) What would be the result of an increase in haircuts on collateral? (a) Increasing haircuts would allow a financial institution to borrow a higher level of funds. (b) Financial institutions would engage in fire sales on assets. (c) With increased collateral requirements, balance sheets of firms and households would greatly improve. (d) The shadow banking system would play an even more prominent role in financial markets.

(b) Financial institutions would engage in fire sales on assets.

(12.3) Which of the following is true of securitization? (a) It is a process that drives the prices of financial instruments above their fundamental economic values. (b) It is a process that converts a series of financial instruments into marketable securities. (c) It is a process that converts high-risk financial instruments into default-free financial instruments. Was the process of securitization solely responsible for the Great Recession of 2007-2009? Which of the following factors apart from securitization was responsible for the Great Recession of 2007-20099=? (a) An increase in the federal funds rate. (b) A sudden rise in equity prices. (c) An increase in funds lend to subprime borrowers.

(b) It is a process that converts a series of financial instruments into marketable securities. No (c) An increase in funds lend to subprime borrowers.

(12.3) Choose the components of the shadow banking system. (Check all that apply). (a) Savings and loan associations. (b) Money market funds. (c) investment banks. (d) Hedge funds. (e) Commercial banks.

(b) Money market funds. (c) investment banks. (d) Hedge funds.

(9.3) If the president of a bank told you that the bank was so well run that it never had to call in loans, sell securities, or borrow as a result of a deposit outflow, would you be willing to buy stock in that bank? Why or why not? (a) Yes, the bank must be offering low-interest rate loans, thereby reducing the moral hazard problem. (b) No, the bank is holding too many excess reserves, and bank profits may be low. (c) No, the bank must be earning more from deposits than from loans, and this is not possible. (d) Yes, the bank is holding enough excess reserves to always cover deposit outflows, so bank profits must be high.

(b) No, the bank is holding too many excess reserves, and bank profits may be low.

(15.3) Based on your previous answer, can we easily measure the effects of such a strategy? (a) Yes. Economists can easily isolate the effects of each strategy. (b) No. during abnormal economic conditions standard models of agent's behavior are not good representations of their decision making process and economists cannot therefore identify the reasons as to why one variable has changed.

(b) No. during abnormal economic conditions standard models of agent's behavior are not good representations of their decision making process and economists cannot therefore identify the reasons as to why one variable has changed.

(15.3) What is the main rationale behind paying negative interest rates to banks for keeping their deposits and central banks in Sweden, Switzerland, and Japan? (a) Paying negative interest rates to banks for keeping their deposits at central banks makes it less costly for banks to pay positive interest rates to their depositors. (b) Paying negative interest rates to banks for keeping their deposits at central banks is supposed to work to stimulate the economy by encouraging banks to lend out the deposits. (c) Paying negative interest rates to banks for keeping their deposits at central banks allows central banks to generate profits on deposits that would have earned nothing in the past.

(b) Paying negative interest rates to banks for keeping their deposits at central banks is supposed to work to stimulate the economy by encouraging banks to lend out the deposits

(12.3) Which of the following statements are likely to be in favor of the idea that the Fed was responsible for the housing price bubble in the mid-2000s in the United States? (Select all that apply) (a) Lowering of lending standards. (b) The Fed set the federal funds rate at an extremely low level. (c) Capital inflows from India and China coupled with no attractive investment opportunities. (d) The Fed was not stringent enough in regulating and monitoring financial intermediaries.

(b) The Fed set the federal funds rate at an extremely low level. (d) The Fed was not stringent enough in regulating and monitoring financial intermediaries.

(9.1) A bank finds that its ROE is too low because it has too much bank capital. Which of the following will not raise its ROE? (a) The bank can increase the amount of its assets by acquiring new funds. (b) The bank can sell part of its holdings of securities and hold more excess reserves. (c) The bank can buy back some of its shares. (d) The bank can pay our more dividends.

(b) The bank can sell part of its holdings of securities and hold more excess reserves.

(15.1) Using the supply and demand analysis of the market for reserves, determine what happens to the federal funds rate, borrowed reserves, and nonborrowed reserves, holding everything else constant, if: Banks expect an unusually large increase in withdrawals from checking deposit accounts in the future. (a) The federal funds rate will decrease, but nonborrowed reserves and borrowed reserves will not change. (b) The federal funds rate will increase and borrowed reserves do not change, or the federal funds rate will remain at the discount rate and borrowed reserves increase. Nonborrowed do not change. (c) The federal funds rate will increase, but nonborrowed reserves and borrowed reserves will not change. (d) The federal funds rate will increase, nonborrowed reserves will decrease, and borrowed reserves will not change.

(b) The federal funds rate will increase and borrowed reserves do not change, or the federal funds rate will remain at the discount rate and borrowed reserves increase. Nonborrowed do not change.

(12.3) Why would haircuts on collateral increase sharply during a financial crisis? (a) There is an increase in demand for loans. (b) There is an increase in the uncertainty over the value of assets. (c) There is a decrease in the number of nondepository financial firms. (d) there is a lack of credit standards and rules.

(b) There is an increase in the uncertainty over the value of assets.

(15.1) "The federal funds rate can sometimes be above the discount rate." Is this statement true, false, or uncertain? (a) False. Once the federal funds rate reaches the discount rate, banks borrow directly from the Fed, preventing the federal funds rate from further rising. (b) True. Banks may prefer to pay a higher market rate than to borrow directly from the Fed and incur the perceived stigma. (c) Uncertain. It depends on the extent to which nonbank financial companies participate in the federal funds market.

(b) True. Banks may prefer to pay a higher market rate than to borrow directly from the Fed and incur the perceived stigma.

(12.2) How does an unanticipated decline in the price level cause a drop in lending? (a) A decline in the price level lowers the nominal value of loan contracts that have already been made. (b) A decline in the price level reduces the moral hazard associated with borrowing firms. (c) A decline in the price level raises the real value of borrowing firms' liabilities while lowering the firms' real net worth. (d) A decline in the price level does not affect lending.

(c) A decline in the price level raises the real value of borrowing firms' liabilities while lowering the firms' real net worth.

(9.3) If a bank experiences a deposit outflow of $50 million with a required reserve ratio on deposits of 10%, which balance sheet would the bank rather have initially: Balance Sheet A or Balance Sheet B? Why? Balance Sheet A Assets: Reserves $75million Loans $525million Liabilities: Deposits $500million Bank Capital $100million Balance Sheet B Assets: Reserves $100million Loans $500million Liabilities: Deposits $500million Bank Capital $100million (a) Since acquiring reserves is nearly costless, Balance Sheet A is more desirable because it can take advantage of holding more income-producing assets until the deposit outflow. (b) Balance Sheet A because the excess reserves are adequate to cover the deposit outflow without the bank needing to alter its balance sheet. Moreover, this balance sheet has more income-producing assets. (c) Balance Sheet B because the excess reserves are adequate to cover the deposit outflow without the bank needing to alter its balance sheet. (d) Since acquiring reserves is nearly costless, Balance Sheet B is more desirable because it can take advantage of holding more income-producing assets until the deposit outflow.

(c) Balance Sheet B because the excess reserves are adequate to cover the deposit outflow without the bank needing to alter its balance sheet.

(12.3) Which of the following statements is likely to contradict the idea that the Fed was responsible for the housing price bubble of the mid-2000s in the United States? (Select all that apply) (a)The Fed set the federal funds rate extremely low. (b) The Fed was not stringent enough in regulating and monitoring financial intermediaries. (c) Capital inflows from India and China coupled with no attractive investment opportunities. (d) Lowering of lending standards.

(c) Capital inflows from India and China coupled with no attractive investment opportunities. (d) Lowering of lending standards.

(14.4) If you decide to hold $100 less cash than usual and therefore deposit $100 more cash in the bank, what effect will this have on checkable deposits in the banking system if the rest of the public keeps its holdings of currency constant? Assume the required reserve ratio of 10% and banks do not hold any excess reserves. (a) Checkable deposits increase by $100 (b) Checkable deposits fall by $1,000 (c) Checkable deposits increase by $1,000 (d) Checkable deposits fall by $100 (e) Checkable deposits do not change.

(c) Checkable deposits increase by $1,000

(9.4) A bank almost always insists that the firm it lends to keep compensating balances at the bank. Why? (Check all that apply) (a) Compensating balances can be used as a substitute for a revolving line of credit. (b) Compensating balances may be converted into income-producing assets, which raises bank profitability. (c) Compensating balances can act as collateral. (d) Compensating balances help establish long-term customer relationships, which make it easier for the bank to collect information about prospective borrowers, thus reducing the adverse selection problem. (e) Compensating balances help the bank monitor the activities of a borrowing firm, which reduces the moral hazard problem.

(c) Compensating balances can act as collateral. (d) Compensating balances help establish long-term customer relationships, which make it easier for the bank to collect information about prospective borrowers, thus reducing the adverse selection problem. (e) Compensating balances help the bank monitor the activities of a borrowing firm, which reduces the moral hazard problem.

(15.2) "the only way that the fed can affect the level of borrowed reserves is by adjusting the discount rate." Is this statement true, false, or uncertain? Explain your answer. (a) True. The fed uses only the discount rate to adjust the amount of discount loans made. (b) False. The fed can also engage in open market operations. (c) False. The fed can also limit the amount of discount loans that an individual bank can have. (d) Uncertain. it depends on whether the discount rate is set lower than the federal funds rate target.

(c) False. the fed can also limit the amount of discount loans that an individual bank can have.

(12.2) What role does weak financial regulation and supervision play in causing financial crises? (a) It reduces the risk that financial institutions will make bad loans. (b) It helps establish tighter rules and regulations for lending activities. (c) It allows financial institutions a better opportunity to engage in excessive risk-taking behavior. (d) It creates higher interest rates, as government expenditures will tend to increase.

(c) It allows financial institutions a better opportunity to engage in excessive risk-taking behavior.

(14.4) Assume that they required reserves ratio on checkable deposits is 10% and the public's holdings of currency do not change. If reserves in the banking system increase by $1 billion as a result of discount loans of $1 billion, and checkable deposits increase by $9 billion, why isn't the banking system in equilibrium. (a) There are $1 billion of excess reserves that banks will seek to lend out. (b) There are $100 billion of excess reserves that banks will seek to lend out. (c) There are $100 million of excess reserves that banks will seek to lend out. (d) The banking system is in equilibrium. Use a T-account for the banking system in equilibrium

(c) There are $100 million of excess reserves that banks will seek to lend out. Banking System Assets: Reserves $1 billion Loans $10 billion Liabilities: Discount Loans $1 billion Checkable deposits $10 billion

(14.7) The money multiplier declined significantly during the period 1930-1933 and also during the recent financial crisis of 2008-2010. Yet the M1 money supply decreased by 25% in the depression period but increased by more than 20% during the recent financial crisis. What explains the difference in outcomes? (a) There was a minimal increase in the currency ratio during the recent financial crisis. (b) The overall level of deposit expansion decreased during the recent financial crisis. (c) There was a significant increase in the monetary base during the recent financial crisis. (d) The excess reserves ratio increased rapidly during the recent financial crisis.

(c) There was a significant increase in the monetary base during the recent financial crisis.

(9.3) If no decent lending opportunity arises in the economy, and the central bank pays an interest rate on reserves that is similar to other low-risk investments, do you think banks will be willing to hold large amounts of excess reserves? (a) No. The bank must manage the liquidity of its assets so that it can meet deposit outflows. (b) No. In managing their assets, banks must attempt to lower risk by diversifying. (c) Yes. Banks will be willing to hold large amounts of excess reserves since these are safe investments.

(c) Yes. Banks will be willing to hold large amounts of excess reserves since these are safe investments.

(9.5) If you are a banker and expect interest rates to rise in the future, would you want to make short-term or long-term loans? (a) You would want to make long-term loans to secure higher interest rate for an extended period of time. (b) You would want to make short-term loans since there is no guarantee that the interest rate will rise as expected. (c) You would want to make short-term loans so you can reinvest the funds at higher interest rates after their maturity. (d) Both short-term and long-term interest loans will be profitable with an expected interest rate increase.

(c) You would want to make short-term loans so you can reinvest the funds at higher interest rates after their maturity.

(15.2) If float decreases below its normal level, why might the manager of domestic operations consider it more desirable to use repurchase agreements to affect the monetary base rather than an outright purchase of bonds? (a) the fed only uses repurchase agreements. (b) changes in float tend to be longer term. (c) changes in float tend to be temporary (d) none of the above are correct.

(c) changes in float tend to be temporary

(15.3) what is the main disadvantage of an unconditional policy commitment? (a) an unconditional commitment is weaker than a conditional commitment so it is likely to have a weaker effect on long-term interest rates. (b) it provides a significant amount of transparency and certainty, which makes in more difficult for markets and households to make decisions about the future. (c) it represents a tacit commitment by the central bank; if conditions suddenly change where a change in the policy stance may be warranted, then holding to the commitment could be destabilizing.

(c) it represents a tacit commitment by the central bank; if conditions suddenly change where a change in the policy stance may be warranted, then holding to the commitment could be destabilizing.

(12.1) Which of the following is associated with asymmetric information in a financial crisis? (a) Adverse selection can occur if lenders must select from a pool or bad credit risks. (b) There is a lack of information about one or more of the parties involved in a transaction. (c) Moral hazard could occur when only borrowers know if the funds will be used to finance high-risk activities. (d) All of the above are correct.

(d) All of the above are correct.

(12.2) How can a bursting of an asset-price bubble in the stock market trigger a financial crisis? (a) A reduction in asset prices causes borrowing firms to have less to lose so they are willing to take additional risk. (b) A reduction in asset prices causes lenders to become more cautious and reduce the amount of loans they make. (c) A reduction in asset prices causes a serious deterioration in borrowing firms' balance sheets. (d) All of the above are correct.

(d) All of the above are correct.

(12.3) Why is the originate-to-distribute business model subject to the principal-agent problem? (a) Once the mortgage broker earns his or her fee, the broker does not care if the borrower makes good on his payment. (b) The more volume the broker originates, the more he or she makes. (c) The mortgage broker has little incentive to ensure the borrower is credit-worthy, since loans will be sold as mortgage-backed securities. (d) All of the above are correct.

(d) All of the above are correct.

(9.4) What is being nosy a desirable trait for a banker? (a) A banker has to screen our good credit risks from bad credit risks. (b) To reduce moral hazard, a banker must continually monitor borrowers to ensure that they are complying with restrictive loan covenants. (c) A banker determines credit risk by learning as much as possible about potential borrowers. (d) All of the above are correct.

(d) All of the above are correct.

(12.3) How did the global financial crisis promote a sovereign debt crisis in Europe? (a) Surging budget deficits raised fears that governments might default on their debt, causing interest rates on that debt to soar. (b) The contraction in economic activity accompanying the financial crisis sharply reduced tax revenues for many governments. (c) Governments outlays rose as bailouts became necessary for failing financial institutions. (d) All of the Above. (e) B and C only.

(d) All of the above.

(9.3) The bank you own has the following balance sheet: Assets: Reserves $75million Loans $525million Liabilities: Deposits: $500million Bank Capital $100million If the bank suffers a deposit ourflow of $50 million with a required reserve ratio on deposits of 10%, what actions can you take to keep your bank from failing? (a) You can borrow reserves in the federal funds market. (b) You can call in or sell off loans (c) You can go to the discount window. (d) Any of the above are appropriate actions to take.

(d) Any of the above are appropriate actions to take.

(14.4) What happens to checkable deposits in the banking system when the Fed sells $2 million of bonds to the First National Bank, assuming that the required reserve ratio on checkable deposits is 10%, banks do not hold any excess reserves, and the public's holdings of currency do not change? (a) Checkable deposits decline by $2 million (b) Checkable deposits increase by $20 million (c) Checkable deposits increase by $2 million (d) Checkable deposits decline by $20 million.

(d) Checkable deposits decline by $20 million

(14.4) If a bank sells $10 million of bonds to the Fed to pay back $10 million on a loan it owes, what will be the effect on the level of checkable deposits? Assume that the required reserve ratio on checkable deposits is 10%, banks do not hold any excess reserves, and the public's holdings of currency do not change. (a) Checkable deposits decline by $1 million (b) Checkable deposits decline by $100 million (c) Checkable deposits decline by $10 million (d) Checkable deposits do not change.

(d) Checkable deposits do not change.

(15.2) why, considering most float changes are temporary, do repurchase agreements fit better than outright purchases? (a) repurchase agreements are used more often for defensive operations (b) repurchase agreements can be easily counteracted if the float changes again (c)repurchase agreements are temporary in their time frame. (d) all of the above are correct.

(d) all of the above are correct.

(15.2) Why is paying interest on reserves an important tool for the Federal Reserve to manage crises? (a) it allows for fluctuations in the federal funds rate, making monetary policy more flexible. (b) it allows the fed to increase the money supply to support excessive demand for goods and services. (c) it allows the fed to increase the effective tax on deposits, thereby increasing economic efficiency. (d) it allows the fed to increase its lending as much as it wants without reducing the federal funds rate.

(d) it allows the fed to increase its lending as much as it wants without reducing the federal funds rate.

(9.1) Rank the following bank assets from most liquid Liquid ​(1) to least liquid​ (4). ​(Enter a numerical value between 1 and​ 4.) Commercial Loans Securities Reserves Physical Capital

1. Reserves 2. Securities 3. Commercial Loans 4. Physical Capital

(14.4) Suppose that the Fed buys $1 million of bonds from the First National Bank. If the First National Bank and all other banks use the resulting increase in reserves to purchase securities only and not to make loans, what will happen to checkable deposits? Assume the required reserve ratio is 10 percent. (a) Checkable deposits increase by $10 million. (b) Checkable deposits decline by $10 million. (c) Checkable deposits decline by $1 million. (d) Checkable deposits increase by $1 million.

1/rr * (delta)R = 1/.10 * 1 million = $10 million. (a) Checkable deposits increase by $10 million.

(14.3) If the Fed lends five banks an additional total of $100 million but depositors withdraw $50 million and hold it as currency, what happens to the reserves and the monetary base? Use T-accounts to explain your answer. Reserves___________, and the monetary base________________.

Five Banks Assets: Reserves $50million Liabilities: Discount Loans: $100million Deposits: -$50million Federal Reserve System Assets: Discount Loans $100million Liabilities: Reserves $50million Currency $50million Reserves increase by $50 million, and the monetary base increases by $100 million.

(15.2) Compare the use of open market operations, loans to financial institutions, and changes in reserve requirements to control the money supply on the basis of the following criteria: flexibility, reversibility, effectiveness, and speed of implementation. Identify the policy tools that have the greatest: Flexibility (changes in the reserve requirement/open market operations/loans to financial institutions) reversibility (changes in the reserve requirement/open market operations/loans to financial institutions) speed of implementation (changes in the reserve requirement/open market operations/loans to financial institutions)

Flexibility: Open market operations Reversibility: open market operations Speed of Implementation: open market operations

(9.5) Suppose that you are the manager of a bank that has $15 million of fixed-rate assets, $30 million of rate-sensitive assets, $24 million of fixed-rate liabilities, and $20 million of rate-sensitive liabilities. Conduct a gap analysis for the bank, and show what will happen to bank profits if interest rates rise by 5 percentage points. The change in banks profits in $_____ million.

Gap analysis = (rate sensitive assets - rate sensitive liabilities) * interest rates = (30-20)*.05=0.5 million.

(14.7) Suppose that the required reserve ratio is 8%, currency in circulation is $610 billion, the amount of checkable deposits is $890 bullion, and excess reserves are $14 billion. The money supply is $_______billion. The currency deposit ratio is $____. The excess reserves ratio is _______. The money multiplier is ________. Suppose the central bank conducts an unusually large open market purchase of bonds held by banks of ​$1 comma 420 billion due to a sharp contraction in the economy. Assuming the ratios you calculated in the previous steps are the same, the money supply should (increase/decrease) to $_____ billion. Suppose the central bank conducts the same open market purchase as in the previous​ step, except that banks choose to hold all of these proceeds as excess reserves rather than loan them​ out, due to fear of a financial crisis. Assuming that currency and deposits remain the​ same, the new amount of excess reserves is ​$_____ billion. The new excess reserves ratio is ________. Money Supply is $________ billion. Money multiplier is _______.

Money Supply = 610+890=$1500 Currency Deposit Ratio = 610/890=0.685 Excess reserves ratio = 14/890=0.016 The money multiplier = (1+c)/(rr+e+c) = (1+0.685)/(0.08+0.016+0.685)=2.16 increase MB=C+R=610+71.2+14+1420=2115.2 ------ M=mm*MB=2.16*2115.2=$4569 billion. ER=14+1420=$1434 billion. e=ER/D=1434/890=1.61 The money supply is still $1500 (neither currency nor deposits changed) m = (1+0.685)/(0.08+1.61+0.685)=0.71

(14.7) What effect might a financial panic have on the money multiplier and the money supply? Why? In a financial panic, you would expect the money multiplier to (increase/decrease/remain the same) and the money supply to (increase/decrease/remain the same), which would cause the excess reserves ratio to (increase/decrease/remain the same). Thus depositors are likely to (not change/increase/decrease) their holdings of currency.

decrease decrease increase increase

(15.2) "considering that raising the reverse requirements to 100% makes complete control of the money supply possible, Congress should authorize the Fed to raise reserve requirements to this level." Congress (should/should not) do this because it will make it more difficult for individuals and businesses to get loans for investments. Congress (should/should not) do this because it provides perfect control over the official measure of the monetary policy. Congress (should/should not) do this because it will reduce the amount of investment that takes place in the economy, which will slow economic growth. Congress (should/should not) do this because it will be very costly to restructure the way the economy works.

should not should should not should not