economics chapter 13

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can be used to extend new loans and make new investments.

excess reserves

a decrease in the discount rate will increase borrowing from the fed and thereby exert a _

expansionary impact on the supply of money

Reduce the interest paid on excess reserves because this will induce banks to hold less reserves and extend more loans, which will expand the money supply.

expansionary monetary policy- interest paid on excess bank reserves

When the supply of money grows rapidly relative to goods and services, its purchasing power will

fall

If the purchasing power of money is to remain stable over time, its supply must be

limited

Because of the increased holdings of excess reserves, the

money supply increased far less rapidly than the monetary base.

Because of the recession and sluggish growth, the demand for loans was

weak

At least one-half and perhaps as much as two-thirds of U.S. currency is held abroad. These dollars are includedin the M1 money supply even though they are not circulating in the U.S..

widespread use of the dollar abroad

Why Didn't the Banks Usethe Excess Reserves to Extend Loans?

There was considerable uncertainty about the future and therefore banks were reluctant to make long-term commitments.

the _ held by the fed are part of the national debt

US treasury bonds

Rapid growth was indicative of

expansionary monetary policy

if the fed wants to reduce the money supply, it will increase the interest rate paid banks on excess reserves. this will provide banks with an _

incentive to hold more reserves, which will reduce the money supply

The M1 money supply

is composed of assets that reflect the medium of exchange function of money.

Credit card balances are a

liability

if the fed wants banks to extend more loans and thereby expand the money supply, it will _

set the interest rate it pays on excess reserves very low, possibly even zero

The money multiplier will be

smaller if either banks hold on to excess reserves or private citizens hold on to cash.

like the discount rate loans, there new types of loans inject additional reserves into the banking system and thereby _

exert an expansionary impact on the money supply

when the fed lowers the required reserve ratio, it creates additional excess reserves, encouraging banks to extend additional loans which _

expands the money supply

Reduce reserve requirements because this will create additional excess reserves and induce banks to extend more loans, which will expand the money supply.

expansionary monetary policy

Extend more loans because this will increase bank reserves, encouraging banks to make more loans and expand the money supply.

expansionary monetary policy- extension of loans

Purchase additional U.S. Securities and other assets, which will increase the money supply and also expand the reserves available to banks.

expansionary monetary policy- open market operations

control of loan volume to banks and other financial institutions

extension of loans

the discount rate is closely related to the interest ration the federal funds market, a private loanable funds market where banks with excess reserves extend short term loans to other banks trying to meet their reserve requirements. the interest rate in this market is called the _

federal funds rate

The seven members of the Board of Governors also serve on the

federal open market committee

the _ created in 1913, is the central bank for the United States.

federal reserve

announcements after the regular meetings of the federal open market committee ofter focus on the _

feds target for the fed funds interest rate

Recent _ have changed the nature of money and reduced the reliability of money growth figures as an indicator of monetary policy.

financial innovations and structural changes

The _ places a ceiling on potential money creation from new reserves.

fractional reserve requirement

Banks are required to maintain only a fraction of their assets as reserves against their customers' deposits (required reserves).

fractional reserve system

the U.S. banking system is a

fractional reserve system

In the past, economists have often used the growth rate of the money supply to

gauge the direction of monetary policy.

the fed controls the federal funds rate through open market operations - the fed can reduce the feds funds rate by buying bonds, which will _ - the fed can increase the fed funds rate by selling bonds, which _

inject additional reserves into the banking system, drains reserves from the banking system

in 2008, the fed also began making loans to non bank financial institutions ( such as _ companies and _) for lengthy time periods (_-_ years)

insurance, brokerage firms, 5, 10

the payment of _ provides the fed with another tool it can use to control the money supply

interest on reserves

setting the interest rate paid banks on reserves held at the fed

interest paid on bank reserves

Most economists now rely on a combination of factors, such as _, to evaluate the direction and appropriateness of monetary policy.

interest rates and growth of nominal GDP

The main purpose of the Fed is to

maintain the proper functioning of our money system.

Banks hold a portion of their assets as reserves (either as cash or deposits with the Fed) to

meet their daily obligations toward their depositors

prior to 2008, the fed extended only short term discount rate loans, and they were extended only to _

member banks

equal to the currency in circulation plus the reserves of commercial banks (vault cash & reserves held at the Fed).

monetary base

important because it provides the foundation for the money supply.

monetary base

Innovations and dynamic changes have altered the nature of money. Economists now place less emphasis on the growth rate of the money supply figures as a

monetary policy indicator

The Fed pushed the interest rate on Treasury bills and other short-term loans to

near zero

credit card purchases are _

not money

buying and selling of U.S. government securities (and other assets) in the open market

open market operations

primary tool used by the federal reserve to control the money supply

open market operations

the buying and selling of US treasury bonds and other financial assets by the fed

open market operations

The lower the percentage of the reserve requirement, the greater the

potential expansion in the money supply resulting from the creation of new reserves.

-is concerned with the finance of federal expenditures -issues bonds to the general public to finance the budget deficits of the federal government -does not determine the money supply

the US treasury

Prior to the financial crisis of 2008, the fed controlled the money supply almost exclusively through open market operations- _

the buying and selling of treasury securities

The main thing that makes money valuable is the same thing that generates value for other commodities:

the demand (for money) relative to its supply

a 12-member board that establishes Fed policy regarding the buying and selling of government securities.

the federal open market committee

-is concerned with the monetary climate of the economy -does not issue bonds -is responsible for the control of the money supply and the conduct of monetary policy

the federal reserve

responsible for the conduct of U.S. monetary policy.

the federal reserve

responsible for the creation of a stable monetary climate for the entire U.S. economy. • It controls the supply of U.S. dollars, • serves as a "banker's bank" or "bank of last resort" for U.S. banks, and, • regulates the banking sector.

the federal reserve

is designed to strengthen the ability of the Fed to pursue monetary policy in a stabilizing manner.

the independence of the federal reserve system

If a sizeable amount of U.S. currency is held outside of the United States,

the money supply figures, particularly those for M1, will be less reliable.

M2 (a broader measure of money) includes:

-M1 - savings deposits - time deposits - money market mutual funds

The banking industry includes:

-commercial banks -savings and loans - credit unions

Fiat money is money

that has little intrinsic value and is not backed by a commodity.

The components of M1 are:

-currency -checking deposits (including demand deposits and interest earring checking deposits) - travelers checks

Actual deposit multiplier will be less than the potential because:

-some persons will hold currency rather than bank deposits, and, - some banks may not use all their excess reserves to extend loans.

A bank receives a demand deposit of $1,000. The bank loans out $600 of this deposit and increases its excess reserves by $300. What is the legal reserve requirement?

10 percent

A reserve requirement of 5 percent implies a potential money deposit multiplier of

20

If the banking system has $50 billion in excess reserves, and the required reserve ratio is 25 percent, what is the maximum amount by which the money supply can be increased?

200 billion

in response to the _ recession, the feds asset holdings skyrocketed

2008-2009

banking institutions are required to maintain _ reserves against transaction account deposits of over 15.2 million and _ for the amounts over 110.2 million

3%, 10%

Suppose the Fed sells $100 million of U.S. securities to the public. If the reserve requirement is 20 percent, the currency holdings of the public are unchanged, and banks have zero excess reserves both before and after the transaction, the total impact on the money supply will be a

500 million decrease

Suppose the Fed bought $150 million of U.S. securities from the public. The reserve requirement is 20 percent, and there are no initial excess reserves. A few weeks later, if the public's holdings of currency are constant and the banks have loaned all excess reserves, the money supply will increase by

750 million

Fed independence stems from:

Lengthy terms for the individual members of the Board of Governors (14 years) • However, the impact of the lengthy terms may be more apparent than real. Because of attractive private sector alternatives, the average tenure of fed governors appointed since 1980 has declined to less than five years. • The Fed derives its revenue from interest on the bonds that it holds rather than allocations from Congress

Two basic measurements of the money supply are _ and _

M1, M2

Which of the following provides the best explanation of why money is valuable?

Money is valuable because it is scarce relative to the demand for the services it provides.

the fed began paying banks interest on their reserves in _

October 2008

Under a fractional reserve system, an increase in deposits will provide the bank with _ and place it in a position to extend additional loans, and thereby expand the money supply.

excess reserves

the Board of Governors of the Federal Reserve System is located in

Washington DC

The type of banking system under which banks are required to hold only a portion of their assets in reserve against the checking deposits of their customers is called

a fractional reserve banking system

Money is an asset used to buy and sell goods and services.

a medium of exchange

Money is an asset that allows people to transfer purchasing power from one period to another.

a store of value

Money is a unit of measurement used by people to post prices and keep track of revenues and costs

a unit of account

money is an _

asset

Banks provide services and pay interest to

attract checking, savings, and time deposits

Most of these deposits are invested and loaned out, providing interest income for the

bank

Banks accept deposits and use part of them to extend loans and make investments. Income from these activities is their major source of revenue

banks are profit seeking institutions

They help bring together people who want to save for the future with those who want to borrow for current investment.

banks play a central role in the capital market (the loanable funds market)

the _ is at the center of the federal reserve operations

board of governors

the _ sets all rates and regulations for the depository institutions

board of governors

when the fed sells bonds the money supply contracts because

bond buyers exchange money for bonds, bank reserves decline which causes them to extend fewer loans

when the fed buys bonds the money supply expands as _

bond sellers acquire money (check from the fed), bank reserves increase, placing banks in a position to expand the money supply through the extension of additional loans

The currency in circulation contributes directly to the money supply, while the bank reserves provide the underpinnings for _.

checking deposits

Each of the district banks monitor the _ in their region and assists them with the clearing of checks.

commercial banks

while media often focuses on the feds target fed funds rate, open market operations are used to _

control this interest rate

The use of a credit card is merely a _

convenient way to arrange for a loan

during 2008, the fed reduced its holding of treasury securities, but vastly expanded its purchase of _. moreover, there was a huge increase in fed loans to non banking institutions such as brokerage firms and insurance companies

corporate bonds, mortgage backed securities, and commercial paper issued by private business

in 2008, the fed established several new procedures for the extension of _ and began _, including some to non-banking institutions

credit, extending longer term loans

raising the reserve requirements _

decreases the money supply

Demand deposits are

deposits of individuals that can either be withdrawn or made payable on demand to a third party by a check.

the interest rate the fed charges banks for short term loans needed to meet reserve requirements

discount rate

In order for barter trades to occur, there must be a

double coincidence of wants.

Increases in the Fed's asset holdings reflect expansionary monetary policy

quantitative easing

People demand money because it

reduces the transaction cost of exchange

The funds that banks are required by law to hold in the form of either vault cash or deposits with the Fed are called

required reserves.

setting the fraction of assets banks must hold as reserves (vault cash or deposits with the Fed), against their checking deposits

reserve requirements

the fraction banks must hold on reserves (vault cash and deposits with the fed) against their checking deposits

reserve requirements

The Fed has 4 major tools it can use to control the money supply:

reserve requirements, open market operations, extension of loans, and interest paid on bank reserves

Vault cash and deposits held with the Federal Reserve count as

reserves

an increase in the discount rate will reduce borrowing from the fed and thereby exert a _

restrictive impact on the money supply

Raise reserve requirements because this will reduce the excess reserves of banks and induce them to make fewer loans, which will contract the money supply.

restrictive monetary policy

Extend fewer loans because this will decrease bank reserves, discourage bank loans, and reduce the money supply.

restrictive monetary policy- extension of loans

Increase interest paid on excess reserves because this will induce banks to hold more reserves and extend fewer loans, which will contract the money supply.

restrictive monetary policy- interest paid on excess bank reserves

Sell U.S. securities and other assets, which will decrease the money supply and also contract the reserves available to banks.

restrictive monetary policy- open market operations

slow growth (or a contraction in the money supply) was indicative of

restrictive policy

Increased use of debit cards & various forms of electronic money have reduced the demand for currency. Like other changes in the nature of money, these innovations have reduced the reliability of the money supply figures as an indicator of monetary policy.

substitution of electronic payments for checks and cash

since 2011, the fed was paying member banks an interest rate equal to the _ on both required and excess reserves

target federal funds rate

member banks have borrowed from the fed, primarily to meet _

temporary shortages of reserves


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