ECON 530 FINAL

Again, suppose that from a new checkable deposit, Econ Global Bank holds two million dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and one million dollars in required reserves. Given this information, we can say First National Bank faces a required reserve ratio of: (a) 10% (b) 12.5% (c) 80% (d) 20%

(a) 10%

When a primary dealer sells a government bond to the Federal Reserve, reserves in the banking system ________ and the monetary base ________ , everything else held constant: (a) increase; increases (b) increase; decreases (c) decrease; increases (d) decrease; decreases

(a) increase; increases

5. Total reserves minus bank deposits with the Fed equals: (a) vault cash (b) excess reserves. (c) required reserves (d) currency in circulation.

(a) vault cash.

High-powered money (this is another name for the monetary base) minus reserves equals: (a) reserves. (b) currency in circulation. (c) the monetary base. (d) the non-borrowed base.

(b) currency in circulation.

Both ______ and _______ are monetary liabilities of the Fed: (a) securities; loans to financial institutions (b) currency in circulation; reserves (c) securities; reserves (d) currency in circulation; loans to financial institutions

(b) currency in circulation; reserves

Suppose that from a new checkable deposit, Econ Global Bank holds two million dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and one million dollars in required reserves. Given this information, we can say Econ Global Bank has million dollars in excess reserves: (a) three (b) nine (c) ten (d) eight

(b) nine Recall that Excess reserves = vault cash + bank deposits at the Fed - required reserves

In the simple deposit expansion model, a decline in checkable deposits of $500 when the required reserve ratio is equal to 20 percent implies that the Fed (a) sold $250 in government bonds. (b) sold $100 in government bonds. (c) sold $50 in government bonds. (d) purchased $100 in government bonds.

(b) sold $100 in government bonds.To arrive at the answer, we first need to get the change in reserves, which is given by: rr ∗ ∆D = 0.20 ∗ $500 =$100 Now think about what action of the Fed would reduce reserves by $100.

If the required reserve ratio is 25 percent, the simple deposit multiplier is (a) 5 (b) 2.5 (c) 4 (d) 10

(c) 4

The three players in the money supply process include: (a) banks, depositors, and the U.S. Treasury (b) banks, depositors, and borrowers (c) banks, depositors, and the central bank (d) banks, borrowers, and the central bank

(c) banks, depositors, and the central bank

Suppose a person cashes his payroll check and holds all the funds in the form of currency. Everything else held constant, total reserves in the banking system ______ and the monetary base ______: (a) remain unchanged; increases (b) decrease; increases (c) decrease; remains unchanged (d) decrease; decreases

(c) decrease; remains unchanged

Individuals that lend funds to a bank by opening a checking account are called: (a) policyholders (b) partners (c) depositors (d) debt holders

(c) depositors

If the Fed decides to reduce bank reserves, it can: (a) purchase government bonds. (b) extend discount loans to banks. (c) sell government bonds. (d) print more currency.

(c) sell government bonds.

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 (a) $75. (b) $750. (c) $37.50. (d) $375.

(d) $375

If reserves in the banking system increase by $100, then checkable deposits will increase by $500 in the simple model of deposit creation when the required reserve ratio is (a) 0.01 (b) 0.10 (c) 0.05 (d) 0.20

(d) 0.20 Recall the formula for deposit creation: ∆D = (1/rr) ∗ ∆R ∆D = $100 and ∆R = $500 so we solve for rr to get 0.20.

The sum of the Fed's monetary liabilities and the U.S. Treasury's monetary liabilities is called: (a) the money supply (b) currency in circulation (c) bank reserves (d) the monetary base

(d) the monetary base

Explain one advantage and one disadvantage of Open Market Operations

Advantage: OMOs are flexible, precise and can be implemented quickly. Since OMOs are con- ducted using U.S. treasury securities, which are highly liquid and has a large trading volume, they are most effective to affect the monetary base and money supply. Disadvantage: If the economy experiences a full-scale financial crisis (like the Great Recession) conventional monetary policy tools like OMOs are not enough to stabilize the economy.

Explain one advantage and one disadvantage of Discount Lending

Advantage: The most important advantage of discount lending is that the Fed uses it to per- form its role as lender of last resort. Disadvantage: Although the Fed can encourage borrowing of reserves by changing the discount rate, it cannot directly control the volume of borrowed reserves. Banks ultimately make the decision whether to borrow from the Fed. As such, discount lending is not as effective as OMOs in affecting reserves and the money supply.

The Fed raises the target federal funds rate.

NBR shifts leftwards To raise the target fed funds rate, the Fed will have to conduct an open market sale of securities, which will shift the supply of non-borrowed reserves to the left. The fed funds rate will increase, and as long as the equilibrium fed funds rate remains below the discount rate, borrowed reserves will remain the same.

Why is the effect of Federal Reserve actions on bank reserves less exact than the effect on the monetary base?

Since the Fed cannot control the amount of discount lending to financial institutions, it does not have perfect control over the amount of reserves, and hence does not have perfect control over the monetary base. This is why we split the base into two components: (i) one that the Fed can control completely through OMO, non-borrowed reserves (NBR) (ii) another that is created by loans from the Fed, borrowed reserves (BR). Recall the formula for NBR: NBR = MB - BR

Explain why the money multiplier, also called "naive" multiplier overstates the true money multi- plier, also called "the real world" multiplier.

The "naive" multiplier ignores the role banks and their customers play in the creation process. The bank's customers can decide to hold currency and the bank can decide to hold excess reserves. Both of these will restrict the banking system's ability to create deposits. Thus, "the real world" multiplier is much less than the prediction of the "naive" multiplier.

Explain two ways by which the Federal Reserve System can increase the monetary base.

The Fed can increase the monetary base by:(i) purchasing government bonds - this causes an expansion of reserves equivalent to the amount of the purchase. An increase in reserves, ceteris apribus, increases the monetary base. (ii) extending discount loans - when banks borrow from the Fed, the bank is credited with reserves amounting to the value of the loan. This increases reserves and the monetary base.

The economy is surprisingly strong, leading to an increase in the amount of checkable deposits.

The downward sloping on the demand curve shifts right. A rise in checkable deposits leads to a rise in required reserves at any given interest rate, and thus shifts the demand curve to the right. If the federal funds rate is initially below the discount rate, this then leads to a rise in the federal funds rate. As shown below, borrowed reserves and non-borrowed reserves do not change. If the federal funds rate is initially at the discount rate, then the federal funds rate will just remain at the discount rate, but borrowed reserves will increase.

Banks expect an unusually large increase in withdrawals from checking deposit accounts in the future.

The downward sloping on the demand curve shifts right. If banks expect that an unusually large increase in withdrawals will occur in the future, they will want to hold more excess reserves today, meaning the demand for reserves will increase at any given interest rate. This will have the same effect on the fed funds rate, NBR, and BR as in part (a) above.

Which of the following is NOT true about the word "autonomous" that economists use? a) Changes in autonomous components are associated with movements along a curve. b) Changes in autonomous components are associated with shifts of a curve. c) The autonomous component of a variable is exogenous. d) The autonomous component of a variable is independent of other variables in the model.

a) Changes in autonomous components are associated with movements along a curve.

Everything else held constant, an autonomous monetary policy easing ________ aggregate ________. a) increases; demand b) decreases; demand c) decreases; supply d) increases; supply

a) increases; demand

Everything else held constant, when financial frictions increase, the real cost of borrowing ________ so that planned investment spending ________ at any given inflation rate. a) increases; falls b) decreases; falls c) decreases; rises d) increases; rises

a) increases; falls

1. In the market for reserves, if the federal funds rate is above the interest rate paid on excess reserves, an open market purchase ________ the ________ of reserves which causes the federal funds rate to fall, everything else held constant. a) increases; supply b) increases; demand c) decreases; supply d) decreases; demand

a) increases; supply

Suppose on any given day there is an excess demand of reserves in the federal funds market. If the Federal Reserve wishes to keep the federal funds rate at its current level, then the appropriate action for the Federal Reserve to take is a ________ open market ________, everything else held constant. a) defensive; sale b) defensive; purchase c) dynamic; sale d) dynamic; purchase

b) defensive; purchase

The long-run aggregate supply curve is a) a vertical line through the non-inflationary rate of output. b) a vertical line through the current level of output. c) a vertical line through the natural rate level of output (potential output). d) a horizontal line through the current level of output.

c) a vertical line through the natural rate level of output (potential output).

1. 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 of reserves and causes the federal funds interest rate to ________, everything else held constant. a) decreases; fall b) increases; fall c) increases; rise d) decreases; rise

c) increases; rise

1. Suppose, at a given federal funds rate, there is an excess supply of reserves in the federal funds market. If the Fed wants the federal funds rate to stay at that level, then it should undertake an open market ________ of bonds, everything else held constant. If the Fed does nothing, however, the federal funds rate will ________. a) sale; increase b) purchase; increase c) sale; decrease d) purchase; decrease

c) sale; decrease

The aggregate demand curve is the total quantity of an economy's a) intermediate goods demanded at different inflation rates. b) intermediate goods demanded at a particular inflation rate. c) final goods and services demanded at a particular inflation rate. d) final goods and services demanded at different inflation rates.

d) final goods and services demanded at different inflation rates.

1. In the market for reserves, a lower discount rate a) decreases the supply of reserves. b) increases the supply of reserves. c) lengthens the vertical section of the supply curve of reserves. d) shortens the vertical section of the supply curve of reserves.

d) shortens the vertical section of the supply curve of reserves.