Chapter 14-The Federal Reserve System

Monetary Aggregates of the U.S. Financial System (Table 14.3) The required reserve ratio is

Table 14.3 Monetary Aggregates of the U.S. Financial System ✓ 25 percent. The required reserves are $20 billion out of $80 billion in total deposits. So, the money multiplier must be 4, which means the required reserve ratio must be 25 percent ($20 billion / $80 billion = 25 percent).

Monetary Aggregates of the U.S. Financial System (Table 14.2) The total money supply (M1) is

✓ $400 billion. M1 is equal to currency held by the public plus deposits in transactions accounts, which in this case is $400 billion ($300 billion + $100 billion).

The Board of Governors consists of

✓ 7 members, appointed for 14-year terms. Long, 14-year terms result in a Fed that is politically independent because the terms span three and a half presidential terms.

Which of the following is true about an increase in the discount rate?

✓ It signals the Federal Reserve's desire to restrain money growth. A higher discount rate discourages borrowing from the Fed, thereby slowing the growth in the money supply.

The current chairman of the Federal Reserve is

✓ Jay Powell. The previous chair, Janet Yellen, was appointed by President Obama and sworn in on February 3, 2014. The current chair is Jay Powell, who became chair in 2018. He has worked under both President Trump and President George H. Bush in various capacities.

Which of the following equals the current yield on a bond?

✓ annual interest payment / current market price of the bond. The annual interest payment divided by the current market price of the bond equals the current rate of return.

Members of the Board of Governors are

✓ appointed by the president and confirmed by the Senate. The Fed is a quasi-governmental institution, requiring the members of the Board of Governors to be appointed through the political process.

If the Fed wants to increase the lending capacity of the system by $60 billion and the reserve requirement is 10 percent, it should

✓ buy $6 billion in bonds from banks. Given a multiplier of 10 (1 / 0.1), a purchase of $6 billion of securities by the Fed can create an additional $60 billion in lending capacity.

An open market purchase occurs when the Fed

✓ buys bonds from the public, increasing bank reserves. An open market purchase occurs when the Fed buys bonds from the public, reducing the number of bonds outstanding and increasing the amount of deposits or reserves in the banking system.

By raising the required reserve ratio, the Fed

✓ can reduce the lending capacity of the banking system. A higher reserve ratio forces banks to reduce lending because more reserves must be set aside for each dollar of deposit.

Suppose the Federal Reserve System has a required reserve ratio of 20 percent. If the Open Market Committee sells $10 billion of securities to the commercial banking system, then before the money multiplier takes effect, initially excess reserves

✓ decrease by $10 billion. By removing reserves from the banking system, the Fed immediately reduces excess reserves by the amount of the open market sale, in this case, by $10 billion.

Assuming a reserve requirement of 20 percent, if the Fed sells $20 billion in bonds in the open market, the lending capacity of the system will eventually

✓ decrease by $100 billion. By removing $20 billion in reserves from the banking system through the money multiplier, the Fed reduces the total lending capacity of the banking system by $100 billion ($20 billion / 0.20 = $100 billion).

If the required reserve ratio is 25 percent and the Federal Reserve sells $100,000 worth of bonds, the money supply can potentially

✓ decrease by $400,000. By removing $100,000 in reserves from the banking system through the money multiplier, the Fed reduces the total deposits, part of the money supply, from the banking system by $400,000 ($100,000 / 0.25 = $400,000).

Suppose the Federal Reserve System has a required reserve ratio of 20 percent. If the Open Market Committee sells $10 billion of securities to the commercial banking system, after the money multiplier takes effect, the money supply can

✓ decrease by $50 billion. By removing reserves from the banking system, the Fed immediately reduces excess reserves by the amount of the open market sale (in this case, by $10 billion). This generates continued contractions of the money supply dictated by the multiplier (1 / 0.20 = 5), so the money supply can decrease by up to $50 billion.

If the Fed wants to sell more government bonds than people are willing to buy, then the Fed should

✓ decrease the price it asks for the bonds. If the price is reduced, the yield will rise, making the bonds a more attractive investment.

Which of the following services is performed by the regional Federal Reserve banks?

✓ holding bank reserves Banks can keep their reserves as vault cash or as deposits at the Fed, which enables the Fed to monitor the actual level of bank reserves.

By raising and lowering the discount rate, the Fed changes the

✓ incentive for banks to borrow reserves. Changing the discount rate impacts the costs of funds for banks, which alters the overall level of lending in the economy and therefore the money supply.

If the Fed buys $25 billion of U.S. bonds in the open market and the reserve requirement is 20 percent, M1 will eventually

✓ increase by $125 billion. The money multiplier is equal to 1 / (required reserve ratio), which allows a $25 billion injection to support $125 billion in additional deposits, which are included in M1.

If the Fed buys $32 billion of U.S. bonds in the open market and the reserve requirement is 10 percent, M1 will eventually

✓ increase by $320 billion. The money multiplier is equal to 1 / (required reserve ratio), which allows a $32 billion injection to support $320 billion in additional deposits, which are included in M1.

If the Fed wants to buy more government bonds than people are willing to sell, then the Fed should

✓ offer bondholders a higher price. To get individuals to part with bonds they don't want to sell, the Fed would need to offer a higher price for the bond.

Which of the following is the principal mechanism used by the Federal Reserve to directly alter the reserves of the banking system?

✓ open market operations Open market purchases and sales of bonds alter the amount of reserves on banks' balance sheets, thereby altering the amount of money they can lend and create. It is the main policy lever used by the Fed.

Through open market operations, the Fed can influence

✓ portfolio decisions. By influencing the portfolio decision, the Fed can encourage individuals to move wealth into bonds, stocks, or deposits at the bank.

Suppose the banks in the Federal Reserve System have $200 billion in transactions accounts, the required reserve ratio is 0.15, and there are no excess reserves in the system. If the required reserve ratio is changed to 0.10, the amount of excess reserves would be

✓ positive $10 billion. If the reserve requirement is changed to 10 percent, the banking system will need only $20 billion in reserves ($200 billion × 0.10) versus the $30 billion needed with a 0.15 required reserve ratio. So, banks will have excess reserves of $10 billion.

A change in the reserve requirement causes a change in all the following except

✓ pretax income. Changes to the level of required reserves do not impact the level of pretax income but will alter the money multiplier, the lending capacity of the banking system, and the level of excess reserves.

A bond is a(n)

✓ promise to repay borrowed funds. A bond is borrowed money, a certificate acknowledging a debt and the amount of interest to be paid each year until repayment.

One of the major functions performed by the Federal Reserve district banks is

✓ providing loans to private banks. Ensuring that member banks can borrow needed reserves to fulfill the minimum required reserve ratio is an important function of the Fed.

The minimum amount of reserves a bank is required to hold is

✓ required reserves. The Fed requires banks to hold a certain percentage of all deposits as reserves called required reserves and is equal to the required reserve ratio multiplied by transaction deposits.

If market interest rates fall, the selling price of existing bonds in the market will, ceteris paribus,

✓ rise. Bond prices and yields move in opposite directions. If the Fed buys government bonds, bond prices rise and yields (interest rates) fall.

If banks do not have enough reserves to satisfy the reserve requirement, they can

✓ sell securities. A bank can sell bonds (securities) to get the funds needed to restore vault cash so that it can meet the reserve requirement ratio.

The Federal Open Market Committee plays a primary role in

✓ setting short-term interest rates and regulating the level of reserves held by private banks. The FOMC plays the very important role of setting short-term interest rates and setting the level of reserves held by private banks.

The Federal Open Market Committee plays a primary role in

✓ setting short-term interest rates and regulating the level of reserves held by private banks. The FOMC plays the very important role of setting short-term interest rates and setting the level of reserves held by private banks.

The Federal Open Market Committee is responsible for

✓ the Fed's daily activity in financial markets. The FOMC plays the very important role of setting short-term interest rates and setting the level of reserves held by private banks.

The Federal Reserve System was created by

✓ the Federal Reserve Act in 1913. President Wilson signed the Federal Reserve Act in 1913 to bring greater stability to the banking system following the Panic of 1907.

Monetary Aggregates of the U.S. Financial System (Table 14.1) If the Fed buys $10 billion in bonds from the public, all of the following are true except

✓ the discount rate will rise. A Fed purchase of $10 billion in bonds would reduce the amount of bonds held by the public and would increase M1 through the money multiplier process. The discount rate would not be affected as this is a separate policy.