Chapter 12
The fractional reserve banking system:
- makes possible the money creation process. - helps to prevent bank runs. -requires banks to hold a portion of their demand deposits in reserve.
Which of the following statements lists contractionary policies?
. The Fed sells bonds, raises the discount rate, and raises the reserve requirements.
Describe the history and structure of the Federal Reserve System and its monetary tools.
Fed structure: -Board of governors (7) appointed by president and confirmed by the senate serve a 14 year term. -12 regional federal reserve banks -Federal open market committee includes board of governors and 5 of the 12 regional banks. Monetary policy tools: -Reserve requirements: By changing the reserve requirement, FED can add or subtract reserves changing the money supply -The discount rate (rate FED charges banks): Interest rate charged by the fed in loans to banks. Fed is lender of last resort.
Define fractional reserve banking and how banks create money
Fractional banking is when banks have to keep some of the money you deposit on reserve. They can loan the excess money out which creates money.
Which of the following is a basic goal of the Federal Reserve System?
Full employment
Explain how an open market operation works, how it affects interest rates, and why it takes time to impact the economy.
Influences bank reserves and federal funds rate—the interest rate banks charge each other. To increase money supply: Fed buys US bonds To reduce money supply: Fed sells US bonds It takes a long time due to various lags: Information Recognition Decision (shorter than for fiscal!) Implementation (can be long)
Define a money leakage and its impact on the money multiplier.
Money leaves the lending cycle, and makes the money multiplier SMALLER. Examples include: Banks holding excess reserves People/firms holding on to cash foreign currency holdings
Define banking regulations such as reserve requirements and deposit insurance.
Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. deposit insurance is protection provided usually by a government agency to depositors against risk of loss arising from failure of a bank or other depository institution.
Explain how the money multiplier works
The money multiplier is the maximum amount the money supply can increase when new deposits are made. Equation: Change in deposits X money multiplier = max increase in money supply
If the reserve requirement is 25%, then a $1 increase in deposits means that the money supply:
has the potential to increase by $4.
The Fed's monetary policies, like fiscal policy, are subject to _____ lags.
information implementation decision
The Fed announced in September 2013 that it would postpone winding down its monetary stimulus until the economic recovery was stronger. When the Fed does finally begin to reduce bond purchases:
interest rates will rise
If the Fed is buying bonds, then it wants bond prices to ____ and the federal funds rate to ____.
rise; fall
The Fed's Board of Governors consists of _____ members who are appointed by the _____ and confirmed by the _____.
seven; President; Senate
Which of the following items is NOT one of the primary tools of the Fed?
tax rates
If the Federal Reserve decides to increase the money supply:
the federal funds rate will fall.
