ECON Chapter 10

Firms, households, and governments use the credit market for borrowing. The credit demand curve shows the relationship between the quantity of credit demanded and the real interest rate. The credit demand curve slopes downward because _______.

A higher real interest rate reduces a borrowing firm's profit and hence its willingness to borrow

Deposit Insurance (FDIC)

A program implement in most counties to protect bank depositors, in full or in part, from losses caused by a bank's inability to pay its withdrawals.

A bank run is

An extraordinarily large volume of withdrawals driven by a concern that a bank will run out of liquid assets with which to pay withdrawals

If narrow banking reduces systemic​ risk, why do banks still practice maturity​ transformation?

Banks still practice maturity transformation simply because it is generally very profitable to do so.

Usury laws place an upper limit on the nominal rate of interest that lenders can charge on their loans. In the 1970s, some credit card companies moved to states where there were no ceilings on interest rates to avoid usury laws. Why would credit card companies move to states without usury laws during a period of high inflation, like the 1970s?

Because usury law ceilings may limit the real return lenders can earn during inflationary periods, lenders have an incentive to move to states without such laws

Venture capital funds usually invest in _________.

Companies that are just starting up and therefore have no track record.

Households and firms with savings lend money to banks and other financial institutions. The credit supply curve shows the relationship between the quantity of credit supplied and the real interest rate. The credit supply curve opens upward because a _________.

Higher real interest rate encourages more saving, and higher real interest rate discourages current consumption

As used in finance, the term maturity referes to the

Time until a debt must be paid repaid

Maturity Transformation

the process by which banks take short-maturity liabilities (like deposits) and invest in long-maturity investments

The discrepancy between the short-term maturities of deposits and the long-term maturities of assets is referred to as _______.

Maturity mismatch

The amount a borrow repays in a year on a one-dollar loan is _______, and the inflation-adjusted purchasing power of the originally borrowed dollar is ______.

1+i , 1+π

Who bears the risk that a bank faces when stockholders' equity is greater than zero?

Bank stockholders

Real Rate of Interest

Nominal rate minus the rate of inflation

The most liquid assets for a household are

Cash and checking accounts

When repaying a loan, the payment a borrower makes consists of ________.

Principal and interest

The inflation-adjusted purchasing power of the originally borrowed dollar is subtracted from the amount a borrower repays in a year on a one-dollar loan. The result is _______.

Real price of the loan, inflation-adjusted cost of the loan, real interest rate

Financial Intermediation

The process by which banks and other financial institutions channel funds from suppliers of financial capital to users of financial capital

How would narrow banking reduce the level of risk in the banking system?

It would reduce risk in the banking system by reducing the likelihood of bank runs and liquidity problems for banks.

A key role of banks is to identify profitable lending opportunities. Banks perform this function by _________.

Matching lenders to the more creditworthy borrowers

When the value of a US bank's assets become less than its liabilities, the government, through the FDIC, __________.

Shuts the bank down and makes payouts to its depositors Searchers for a healthy bank to take over its operations

When the value of a bank's assets is greater than its liabilities, the bank is said to be _________.

Solvent

If a bank runs short of​ reserves, a reasonable step would be to​ ____________.

Stop making new loans Sell some of its illiquid long-term assets

When large firms and the general banking community lose confidence in a weak​ bank, FDIC insurance is _______________ the situation.

incapable of alleviating

When households feel more pressure to save, a credit ________ emerges, cause the real interest rate to _________.

Shortage, decrease

A shift in the credit supply curve can be caused by ___________.

An aging population that is ill-prepared for retirement A heightened desire on the part of firms to internally fund their future activities An elevated perception on the part of households that the future may hold many "rainy days"

A cash equivalent would be recorded as ______ on the bank's balance sheet and is considered ______, as it's value _______ from day to day.

An asset, riskless, remains constant

On a household's annual balance sheet, a one-time loan made to a relative would ________ and purchasing a car with cash would __________.

Be included as a loan on the assets side, decrease the cash available to the buyer on the assets side

A shift in the credit demand curve can be caused by _________.

Changes in government policy Changes in household preferences or expectations Changes in perceived business opportunities for firms

Explain why you think that the crisis prompted banks to dramatically expand the amount of excess reserve they held.

Confidence was shaken so severely by the crisis that banks chose to effectively ration credit amount viable borrowers, including other banks. There was a sharp decline in profitable private sector lending opportunities for financial intermediaries. The Federal Reserve made excess reserves attractive to hold by paying interest for the first time in history.

The two basic types of financial capital are

Credit and equity

If the economy experiences an unexpectedly low rate of inflation, the group that would tend to benefit is ________.

Creditors (people or institutions that are owed money)

How would the failure of a systemically important financial institution (SIFI) affect the economy?

Financial intermediation would likely be impaired, with negative consequences for the economy's performance.

Economic agents who borrow funds are know as ______, the funds that they borrow are referred to as ______, and this activity occurs in the ________ market.

Debtors, credit, credit or loanable funds market

Failure of an investment bank is typically more serious than failure of a regional bank because

Investment banks are not FDIC insured, liabilities are larger, and bank runs can trigger stock market collapses

The decline in the net asset value of other mutual funds ____________.

Is an example of systemic risk, where an event at one institution has impacts that reverberate throughout the system

Explain why banks would be expected to try to minimize the amount of excess reserves that they hold.

Normally, other assets can be expected to generate much higher returns for banks. Banks are privately owned business and this have the goal of maximizing profits for their shareholders. Excess reserve yield little in the way of earnings for banks, this making difficult the generation of satisfactory profit.

Banks usually hold a small pool of reserves because​ ____________.

On most days the withdrawals of existing deposits are roughly offset by inflows of new deposits.

What are the two views on why asset prices fluctuate so much that they lead to financial crises and bank failures?

One view holds that asset prices are rationally based on fluctuating fundamentals, while the other asserts that psychological factors and biases play a significant role.

Nominal Rate of Interest

Real rate of interest + rate of inflation

What steps do bank regulators take to prevent SIFIs from failing or to minimize the effect of such​ failures?

Require banks to establish "living wills," procedures for their treatment in the event they become insolvent. Mandate that banks hold more stockholders' equity. Require banks to take on less risk

In a household's balance sheet _______.

The assists side and the liabilities side will not necessarily be equal. Many households face large debts such as credit card debt and have liabilities greater than assets.

What is a stockholder's equity?

The difference between a bank's total assets and total liabilities

During the financial crisis of 2007-2008, the federal government decided to bail out the big banks, but not any of the households that had lost money because of their investments or house purchases. This is justified because

The government can easily impose restrictions on the transactions of banks, but it is difficult for the government to monitor the finances of individuals

How is the rate of inflation related to the nominal interest rate that credit card companies charge and why would lenders need to increase the nominal interest rate when the inflation rate increases?

The nominal rate of interest is the real rate of interest plus the rate of inflation; lenders need to raise the nominal rate when inflation increases to maintain their desired real return.

What is the difference between nominal and real interest rates?

The real interest rate is the nominal interest rate adjusted for inflation, and the nominal interest rate is the rate you pay on a loan.

One of the major functions of banks is to _________.

Transform short-maturity liabilities into long-maturity assets. This process is called maturity transformation

Excluding cases where banks had accumulated a lot of​ non-deposit liabilities that are not covered by FDIC​ insurance, would analysts generally agree that deposit insurance has been successful in preventing bank​ runs?

Yes, since bank runs and bank failures have been relatively rare since the advent of deposit insurance.

When a bank experiences withdrawals of deposits and​ short-term loans by firms and other​ banks, the situation is described as​ ____________.

an institutional bank run