Ch15 Finance

Briefly explain​ why, with the monetary policy tools it had used prior to the financial​ crisis, the Fed could not control the federal funds rate.

After excess reserves became​ abundant, changes in reserves due to open market operations led to almost no movement in the federal funds rate.

What is an open market​ operation? Why does the Fed engage in open market​ operations?

An open market operation is when the Fed buys or sells securities in financial markets . The Fed engages in open market operations in order to influence bank reserves and short-term interest rates .

At what interest rate does the demand curve for reserves become perfectly​ elastic?

At the interest rate the Fed pays on​ banks' reserve balances.

​[Related to the Apply the​ Concept: "Are Negative Interest Rates an Effective Monetary Policy ​Tool?"​] In May​ 2020, an article in the Economist discussing negative interest rates observed that as a result of negative interest​ rates, "Less profitable banks . . . might opt to curtail their​ lending, choking off investment and​ growth." If a central bank begins paying a negative interest rate on the reserve deposits of​ banks, why might banks become less​ profitable?

Banks would have to pay interest on their deposits at the central​ bank, which means banks will be less profitable if they cannot make up for the lost revenue somewhere.

In a speech to the Fed conference in Jackson​ Hole, Wyoming, given eight months after the Fed had raised its target for the federal funds rate for the first time since​ 2006, then Fed Chair Janet Yellen observed that the 2007-2009 financial crisis had revealed the​ Fed's "inability to control the federal funds rate once reserves were no longer relatively​ scarce." She went on to​ state: "To address the challenges posed by the financial crisis . . . the Federal Reserve significantly expanded its monetary policy toolkit. . . . Our current toolkit proved effective last December. In an environment of superabundant​ reserves, the FOMC raised the effective federal funds​ rate." What does Yellen mean by​ "reserves were no longer relatively​ scarce"? Before the financial​ crisis, banks chose to hold relatively low levels of excess​ reserves, but since the 2007-2009 financial​ crisis, banks are choosing to hold significantly more excess reserves.

Before the financial​ crisis, banks chose to hold relatively low levels of excess​ reserves, but since the 2007-2009 financial​ crisis, banks are choosing to hold significantly more excess reserves.

Briefly describe the procedure the Fed follows in implementing them. The need for open market operations is determined by the Federal Open Market Committee​, while the execution of the open market operation is conducted by the Federal Reserve Bank of New York.

Briefly describe the procedure the Fed follows in implementing them. The need for open market operations is determined by the Federal Open Market Committee​, while the execution of the open market operation is conducted by the Federal Reserve Bank of New York.

​[Related to the Making the Connection​] What legislative change and financial innovations occurred after 1979 that changed M1 from representing a pure medium of exchange to also representing a store of​ value?

Congress authorized NOW accounts on which banks can pay interest. Banks developed automated transfer of saving​ accounts, which move checkable deposit balances into​ higher-interest CDs each night and then back into checkable deposit balances in the morning.

In an interview in July​ 2020, during the​ Covid-19 pandemic, Federal Reserve Bank of Dallas President Robert Kaplan​ stated: "I just​ don't want to pull out one objective . . . pulling out inflation . . . without regard to other​ considerations, and without regard to the second part of the dual​ mandate." What was Kaplan referring to as the​ "second part of the dual​ mandate"?

High employment

What​ trade-offs does the Fed​ face, particularly in the short​ run, in attempting to reach its​ goals?

In attempting to reach high economic growth or high​ employment, the Fed would pursue expansionary monetary​ policy, but this policy could cause higher inflation.

It would be hard for the Fed to have a set policy of deflating asset bubbles when it being so hard to determine whether asset prices are inflated above their fundamental value or not.

It would be hard for the Fed to have a set policy of deflating asset bubbles when it being so hard to determine whether asset prices are inflated above their fundamental value or not.

Why would this change in M1 break the​ short-run link between money and​ inflation?

M1 became more a store of value than a pure medium of exchange.

​Can't the banks maintain their profitability by paying negative interest rates on the deposits of households and​ firms?

Not​ necessarily, as many depositors would remove deposits from their banks and look for better returns elsewhere.

Briefly discuss potential drawbacks to making this switch.

Only A and C are correct. A. Measures of real GDP may be based on inaccurate data and need revising. C. Nominal GDP targeting is less​ understood, so it may be ineffective at communicating the​ Fed's intentions.

Place the following in​ sequence, from what the Fed has the most influence on to what the Fed has the least influence​ on: policy​ goals, policy​ tools, policy​ instruments, intermediate targets. From the most influence to the least​ influence: policy tools ​, policy instruments ​, intermediate targets ​ and policy goals .

Place the following in​ sequence, from what the Fed has the most influence on to what the Fed has the least influence​ on: policy​ goals, policy​ tools, policy​ instruments, intermediate targets. From the most influence to the least​ influence: policy tools ​, policy instruments ​, intermediate targets ​, and policy goals .

​[Related to the Making the​ Connection] A columnist for bloomberg.comopens in a new tab observes​ that: "The Fed is easily able to tell when unemployment or inflation is​ high, but inflated asset prices are​ much, much harder to identify." ​Source: Noah​ Smith, "Fed Rates Are the Wrong Tools to Fight Bubbles." bloomberg.comopens in a new tab​, July​ 6, 2016. Part 2 Which of the following might be a reason to explain the difficultly in identifying inflated asset​ prices?

Reasonable investors can have widely varying expectations of future profitability.

Why might the Fed want to switch from having a target for the inflation rate to having a target for the growth rate of nominal​ GDP?

Targeting the growth rate of nominal GDP allows monetary policy to respond to changes in both inflation and GDP.

What are the three new tools for managing the federal funds rate that the Fed has relied on in recent​ years? ​(Check all that apply.​)

The Fed began selling term deposits to banks in order to impact the quantity of excess reserves they choose to hold. The Fed began paying interest on bank reserves to better control the quantity of excess reserves banks hold. The Fed began engaging in overnight reverse repurchase agreements by selling securities to financial firms overnight.

Determine whether each facility listed below was a liquidity facility or credit facility used by the Fed during the 2020​ Covid-19 pandemic. Name and Description of Facility Primary Market Corporate Credit Facility: The Fed made loans to corporations in the form of newly issued bonds.

The Fed made loans to corporations in the form of newly issued bonds. Liquidity facility Commerical Paper Funding Facility The Fed used this facility to buy commerical paper directly from corporations Credit facility Fecility for Foreign and Internation Monetary Authorities: The Fed exchanged Treasury bonds held abroad for dollars as needed. Credit facility

When it passed the Federal Reserve Act in​ 1913, Congress did not at first expect that the Fed would engage in open market operations. An article in a Federal Reserve publication notes that after the Fed first began buying Treasury​ securities: "Fed officials realized that by purchasing securities on the open​ market, Federal Reserve Banks could affect general credit conditions across the country." ​Source: "Discovering Open Market ​Operations," Federal Reserve Bank of Minneapolis Region​, August​ 1, 1988. Part 2 What does the article mean by "general credit conditions in the country"​?

The availability of loans and the interest rates on those loans.

The​ Fed's purchases of Treasury securities increases bank​ reserves, giving banks more funds​ (reserves) with which to make loans.

The​ Fed's purchases of Treasury securities increases bank​ reserves, giving banks more funds​ (reserves) with which to make loans.

Explain the effect on the demand for reserves or the supply of reserves of the following Fed policy​ action: A decrease in the discount rate.

This would lower the interest rate at which the supply for reserves become horizontal.

What are the reasons banks demand​ reserves?

To hold excess reserves to meet their​ short-term liquidity needs. To meet their legal obligation to hold required reserves.

When Congress gave the Fed a dual​ mandate, why did they choose these two monetary policy​ goals?

When the Fed achieves these two policy​ goals, it usually also leads to achieving its other goals.

Why does an increase in the federal funds rate decrease the quantity of reserves​ demanded? As the federal funds rate increases​, the opportunity cost to banks of holding excess reserves increases because the return they could earn from lending out those reserves goes up.

Why does an increase in the federal funds rate decrease the quantity of reserves​ demanded? As the federal funds rate increases​, the opportunity cost to banks of holding excess reserves increases because the return they could earn from lending out those reserves goes up.

What is the aim of monetary​ policy? Monetary policy aims to

advance the economic​ well-being of the​ country's citizens.

What is the relationship between the federal funds rate and the interest rates on​ 30-year mortgages and on Aaa and Baa rated corporate​ bonds? These rates generally​ ________.

move​ together, although the federal funds rate often increases and decreases more than these​ long-term rates.

Which two of these tools are most​ important? The two most important tools are​ ________.

paying interest on bank reserves and overnight reverse repos

Economic​ well-being is typically determined by the

quantity and quality of goods and services that individuals can enjoy.