Money and Banking FNCE 4500
If the required reserve rate is 10 percent and banks do not hold any excess reserves and there are no changes in currency holdings, a $1 million open market purchase by the Fed will result in deposit creation of
$10 million.
In 2018, the average daily volume on the Federal Reserve's Fedwire system was
$2.8 trillion.
You have savings accounts at two separately FDIC-insured banks. At one of the banks your account has a balance of $200,000. At the other bank the account balance is $60,000. You find out the banks are going to merge. If this happens and the merged bank fails, you would receive
$250,000.
You have two savings accounts at an FDIC-insured bank. You have $225,000 in one account and $40,000 in the other. If the bank fails, you will receive
$250,000.
You hold an FDIC-insured savings account at your neighborhood bank. Your current balance is $275,000. If the bank fails you will receive
$250,000.
You have savings accounts at two separately FDIC-insured banks. At one of the banks your account has a balance of $200,000. At the other bank the account balance is $60,000. If both banks fail, you will receive
$260,000.
If M = the money supply, Y = real output, P = the price level, and V = velocity, which one of the following equals the velocity of money?
(P × Y)/M
Using the equation of exchange, if real GDP increases by 3.0 percent, the velocity of money grows by 1.0 percent and the growth rate of money is 3.0 percent; what is the rate of inflation?
+1.0 percent
Using the equation of exchange, if inflation is 1 percent, the velocity of money grows by 1.0 percent and the growth rate of money is 3.0 percent; what is real growth?
+3.0 percent
Use the following formula for the Taylor rule to determine the target federal funds rate.target federal funds rate = natural rate of interest + current inflation + ½(inflation gap) +½(output gap)where the current rate of inflation is 5 percent, the natural rate of interest is 2 percent, the target rate of inflation is 2 percent, and output is 3 percent above its potential, the target federal funds rate is
10 percent.
The need for a lender of last resort was identified as far back as
1873, by British economist Walter Bagehot.
The components of the formula for the Taylor rule include each of the following, except which one?
30-year U.S. Treasury bond rate
Consider a bank with the following balance sheet. If the bank is holding no excess reserves, what is the required reserve rate?
5%.
If a bank has $150 million in assets and a net worth of $20 million, its asset-to-equity ratio is
7.5 to 1.
Use the following formula for the Taylor rule to determine the target federal funds rate.target federal funds rate = natural rate of interest + current inflation + ½(inflation gap) +½(output gap)where the current rate of inflation is 4 percent, natural rate of interest is 2 percent, target rate of inflation is 2 percent, and output is 3 percent above its potential, the target federal funds rate is
8.5 percent.
If a bank has $100 million in assets and a net worth of $10 million, its debt-to-equity ratio is
9 to 1.
The Taylor rule is
An approximation that seeks to explain how the FOMC sets their target.
The quantity theory of money along with the assumption of constant velocity can explain which one of the following?
At a given level of money growth, the higher the level of real growth the lower the level of inflation will be.
In the U.S., the authority to issue currency is held by the
Federal Reserve.
Monetary policy in the United States is under the control of the
Federal Reserve.
The quantity theory of money can explain which one of the following?
If the %ΔY > 0 and the %ΔV = 0, then %ΔP < %ΔM.
How was the Dodd-Frank Act of 2010 relatively inefficient?
It failed to adopt least-cost mechanisms to make the financial system more resilient.
If M = quantity of money, m = money multiplier, MB = monetary base, C = currency, D = deposits, R = reserves, RR = required reserves, and ER = excess reserves, then m would equal
M/MB.
If M = quantity of money, m = money multiplier, MB = monetary base, C = currency, D = deposits, R = reserves, RR = required reserves, and ER = excess reserves, then C + R would equal
MB
Which one of the following expresses the equation of exchange?
MV = PY
If we let Md reflect money demand, in equilibrium in the money market, we can write the equation for money demand as
Md = (1/V)PY.
The government regulates bank mergers, sometimes denying the proposed merger. Often the reason given for the denial is to protect small investors. What are small investors being protected from?
Mergers can increase the monopoly power of banks, and the bank may seek to exploit this power by raising prices and earning unwarranted profits.
If M = quantity of money, m = money multiplier, MB = monetary base, C = currency, D = deposits, R = reserves, RR = required reserves, and ER = excess reserves, then RR would equal
R - ER.
The relationship between stability and economic growth is best summarized by which one of the following statements?
Stability results in higher output growth rates.
The Fed purchases German bonds from commercial banks. Which one of the following best describes the impact on the Fed's and the banking system's balance sheets resulting from this transaction?
The Fed's assets and liabilities increase. For the banking system, the value of assets and liabilities do not change, only the composition of assets changes.
Which one of the following correctly portrays a commercial bank's balance sheet?
Total Bank Assets = Total Bank Liabilities + Total Bank Capital
Over the years, most monetary policy experts would agree with each of the following statements, except which one?
Transparency in policy making hinders accountability.
You are given the following information: Total Reserves (R) in the banking system amount to $48 billion, of which $45.8 billion are required. Currency in the hands of the public amounts to $692.5 billion while checkable deposits amount to $650 billion. Calculate the money multiplier.
We can answer this by using the following We need to calculate C/D; this we can obtain by using information given in the question. C = $692.5 (we'll leave off the billions) and D = $650; so C/D = $692.5/$650 = 1.065. Next we'll calculate rD which can be found by rD = RR/D where RR represents the required reserves. We find rD = $45.8/$650 or 0.07. Next, we can find rE by first determining the amount in excess reserves, ER. ER = R − RR or ER = $48 − $45.8 = $2.2. rE = ER/D = $2.2/$650 = 0.0033. We have all of the values we need to solve for m. Substituting the values we obtained into the equation shown, we find that m = 2.065/1.138 or m = 2.35.
What would be the amount of deposits D, given that the monetary base MB = $750 billion, the required reserve rate (rD) = 0.1, the excess reserve rate (rE) = 0.005, and non-bank currency to deposits (C/D) = 1.2?
We can solve for D using the following equation: ; substituting in the values given, we obtain $574.7 billion.
Which one of the following statements is true?
While the Fed emphasizes money growth less than the ECB, both central banks have chosen interest rates as their operating target.
Inflation can be thought of as
a decrease in the price of money.
For every $100 in assets, a bank has $40 in interest-rate sensitive assets, and the other $60 in non-interest-rate sensitive assets. The same bank has $50 for every $100 in liabilities in interest-rate sensitive liabilities while the other $50 are in liabilities that are not interest-rate sensitive. If the interest rate on assets increases from 5 to 6%, and the interest rate on liabilities increases from 3 to 4%, the impact on the bank's profits per $100 of assets will be
a decrease of $0.10.
The Financial Crisis of 2007-08 occurred in three distinct phases which, in the order of occurrence, are
a liquidity crisis, a solvency crisis, and a recapitalization of the system.
Vault cash is
a part of reserves and an asset of commercial banks.
For every $100 in assets, a bank has $30 in interest-rate sensitive assets, and the other $70 in non-interest-rate sensitive assets. The same bank has $60 for every $100 in liabilities in interest-rate sensitive liabilities while the other $40 are in liabilities that are not interest-rate sensitive. If the interest rate on assets decreases from 6 to 5%, and the interest rate on liabilities decreases from 4 to 3%, the impact on the bank's profits per $100 of assets will be
a reduction of $0.30.
The financial system is inherently more unstable than most other industries due to the fact that
a single firm failing in banking can bring down the entire system unlike in most other industries.
Gold is
a small portion of the Fed's assets.
For the Fed to use money growth as a direct monetary policy target, which of the following needs to exist?
a stable link between the monetary base and the quantity of money and a predictable relationship between the quantity of money and the rate of inflation
The monetary policy framework is
a way to prioritize and implement the central bank's objectives when they are in conflict.
The interest rate on primary credit extended by the Fed is
above the IOER.
The interest rate the Fed charges for secondary credit is
above the primary discount rate.
Most economists agree that the target rate of inflation for central banks should be
above zero for fears of deflation.
A liability of the central bank in functioning as the bankers' bank is
accounts of commercial banks.
Interest rate volatility is a problem because it
adds to uncertainty, thereby diminishing an investment.
Today, most central banks announce their policy actions
almost immediately.
When nominal interest rates are high, the velocity of money should
also be high.
Suppose the Federal Reserve purchases a U.S. Treasury bond for $1 million by writing a check. When the check returns, the Fed's balance sheet will show
an increase in assets and liabilities of $1 million.
When the Fed makes a discount loan, the impact on the Fed's balance sheet will reflect
an increase in assets and liabilities.
When the Fed makes a discount loan, the impact on the banking system's balance sheet will reflect
an increase in assets and liabilities.
If money were valued in terms of how many minutes a person needs to work to buy a dollar, an increase in the number of minutes of work needed would be
an increase in the price of money.
If the required reserve rate is ten percent and banks do not hold any excess reserves and there are no changes in currency holdings, a $1 million open market purchase by the Fed will result in which change in loans?
an increase of $10 million
Based on the analysis of the equation of exchange, Irving Fisher derived the quantity theory of money which states that changes in the aggregate price level
are caused solely by changes in the quantity of money.
Control of money growth to stabilize inflation only works if velocity is constant. In practice, changes in velocity
are important when inflation is low.
Secondary credit provided by the Fed is designed for banks that
are in trouble and cannot obtain a loan from anyone else.
Targeted asset purchases are
asset purchases that shift the composition of the Fed's balance sheet.
Reserves are
assets of commercial banks and liabilities of the central bank.
The federal government is concerned about the health of the banking system for many reasons, the most important of which may be that
banks are of great importance in enabling the economy to operate efficiently.
The government is "lender of last resort" to which one of the following groups?
banks that experience sudden deposit outflows
Banks can effectively choose their regulators by deciding whether to
be chartered at the national or state level.
Bonds issued by a foreign government in its own currency would
be held by the Fed as part of its foreign exchange reserves.
Bonds issued by the U.S. Treasury would
be held by the Fed as part of its securities.
Most economists agree that a well-designed central bank would
be independent of political pressure.
Setting an explicit numerical inflation target is most associated with the goal(s) of
both transparency and accountability.
The interest rate decisions made by the Federal Open Market Committee
cannot be overridden by anyone outside of the Federal Reserve.
A bank's net worth is synonymous with its
capital.
Whenever central bankers face more than one goal, the policy framework requires
central bankers to make their priorities clear.
The Fed can do which of the following in the economy?
change both interest rates and the supply of money
Cyber risk is reduced through
cloud computing and other information redundancies.
In the United States, monetary policy is formed by
committee.
Cyber risk describes losses that result from
compromised information systems.
The types of loans the Fed makes consist of each of the following, except which one?
conditional credit
To be independent, a central bank must have
control of its own budget.
One function of modern central banks is to
control the availability of money and credit.
If the nominal interest rate decreases, the
cost of holding money decreases.
If the nominal interest rate increases, then the
cost of holding money increases.
History shows that
countries with high rates of money growth have high rates of inflation.
When the Federal Reserve was unable to stem the bank panics of the 1930s, Congress responded by
creating the FDIC and offering deposit insurance.
The ability to control inflation expectations is most closely related to a central bank's
credibility.
The key to the success of forward guidance as a monetary policy tool is
credibility.
Each of the following items would appear as assets on the central bank's balance sheet except which one?
currency
The monetary base is the sum of
currency in the hands of the public and reserves in the banking system.
The conventional policy tools available to the Fed include each of the following, except which one?
currency-to-deposit ratio
Use the following formula for the Taylor ruletarget federal funds rate = natural rate of interest + current inflation + ½(inflation gap) +½(output gap)to determine what would happen if output in the economy were to fall by an additional one percent below potential. Then, the target federal funds rate would
decrease by 0.5 percent.
Use the following formula for the Taylor ruletarget federal funds rate = natural rate of interest + current inflation + ½(inflation gap) +½(output gap)to determine what would happen if the inflation rate in the economy were to fall by 2 percent below the target inflation rate. Then, the target federal funds rate would
decrease by 3.0 percent.
Mary decides to withdraw $500 out of her checking account. The impact of this transaction on the banking system's balance sheet will be to
decrease reserves and checkable deposits by $500, respectively.
A central bank's sale of securities from its portfolio will
decrease the size of its balance sheet.
Everything else equal, if the ratio of bank assets to bank capital decreases, the bank's return on equity should
decrease.
The government provides deposit insurance which protects
depositors for up to $250,000 should a bank fail.
The market for reserves derives from the fact that
desired reserves do not always equal actual reserves.
Harry gets $1,000 in currency from his grandfather when he graduates from college. He deposits these funds into his checking account. What is the impact of Harry's deposit on the monetary base? The monetary base
did not change.
Which one of the following would not be considered an unconventional monetary policy tool?
discount rate
The velocity of money equals nominal GDP
divided by the money supply.
Governments supervise banks mainly to do each of the following, except which one?
eliminate all risk faced by depositors and investors.
Exchange rate stability is likely to be a more important goal for the central banks of
emerging market economies than the central bank of the United States.
If money growth and real output growth are both zero, the change in the price level will
equal the percentage change in velocity.
The difference between a bank's reserves and its required reserves is
excess reserves.
Quantitative easing is
expansion of the supply of aggregate reserves beyond the amount needed to maintain the policy rate target.
Contagion is the
failure of one bank spreading to other banks through depositors withdrawing of funds.
The rationale for the existence of central banks is mainly that
financial systems are prone to periods of extreme volatility.
Under the purchase-and-assumption method of dealing with a failed bank, the FDIC
finds another bank to take over the insolvent bank.
A moral hazard situation arises in the lender of last resort function because a central bank
finds it difficult to distinguish illiquid from insolvent banks.
The problem for a central bank setting a zero-inflation policy would be that
firms would have to cut the nominal wage to reduce the real wage.
A central bank holds foreign exchange reserves for
foreign exchange interventions.
The procedure that estimates the interest-rate sensitivity of a bank's assets and liabilities is called
gap analysis.
Governments employ three strategies to contain the risks created by government safety nets. These include each of the following, except which one?
government taxation
On the morning of September 11, 2001, terrorists attacked the United States and caused enormous disruptions. In assessing the performance of the Fed and the impact on financial systems in hindsight, this is a story of
great success by the Federal Reserve.
If a bank has $200 million in deposits, the required reserve rate is 10% and the bank has $23 million in reserves, then the bank
has excess reserves of $3 million.
The specific goals of central banks include each of the following except which one?
high levels of exports
In high inflation countries, inflation rates can exceed the rate of growth of money because
high rates of inflation increase the opportunity cost of holding money.
The monetary base is also known as
high-powered money.
Inflation targeting does all of the following, except which one?
hinder economic growth
Often, central banks that employ inflation targeting have a hierarchical mandate that means that
hitting the inflation target comes first, and everything else comes second.
When healthy banks fail due to widespread bank panics, those who are likely to be hurt are
households and small businesses.
As a person's wealth increases, we would expect the demand for money to
increase but at a rate less than dollar for dollar.
If Bank A sells a $100,000 U.S. Treasury bond to the Fed, Bank A's total reserves will
increase by $100,000.
A decline in the yields earned by bonds should
increase the demand for money.
When interest rates fall, a bank's capital will usually
increase.
The government's providing of deposit insurance and functioning as the lender of last resort has significantly
increased the amount of regulation of banks required and increased the incentive for banks to take on risk.
a decrease in the price of money.
increases if each unit of money is used more frequently.
The reason that a run on a single bank can turn into a bank panic that threatens the entire financial system is
information asymmetries.
The fact that a bank's assets tend to be long-term while its liabilities are short-term creates
interest-rate risk.
A major contributing factor to the instability of money demand over the past 25 years is the
introduction of financial instruments that pay higher returns than money but can be used as a means of payment.
The demand for money varies
inversely with the liquidity of other financial assets.
Discount lending by the Fed
is usually small except in times of crisis.
If we look at the value of money in terms of how many units of a good it takes to buy one dollar, then inflation means
it would take fewer goods to buy the same dollar.
The government's too-big-to-fail policy applies to
large banks whose failure would start a widespread panic in the financial system.
Discount lending is part of the Fed's function of
lender of last resort.
On a bank's balance sheet,
liabilities show the sources of funds and assets show the uses of funds.
A rumor starts that a bank has suffered significant losses and may not be able to honor its promises to depositors. This causes most of the depositors to line up in front of the bank the next morning wanting to withdraw their deposits. This is an example of
liquidity risk.
Many people believed that when the calendar changed from December 31, 1999, to January 1, 2000, many bank records were going to be wiped out. If this had caused people to withdraw all of their funds, this would be an example of
liquidity risk.
Each of the following items would appear as liabilities on the central bank's balance sheet except which one?
loans
If the market federal funds rate were above the target rate, the response from the Fed would likely be to
lower the IOER (interest rate on excess reserves).
Use the following formula for the Taylor rule: target federal funds rate = natural rate of interest + current inflation + ½(inflation gap) +½(output gap)to determine the change in the target federal funds rate for every one percent decrease in the rate of inflation. This will
lower the target federal funds rate by 1.5 percent.
Unconventional policy tools are useful when
lowering the target interest rate to zero is not sufficient to stimulate the economy.
Discount loans are
made when banks need relatively small amounts of cash for the short term.
One reason for having a monetary policy framework is that it
makes clear what specific goals the central bankers are pursuing.
Which one of the following is the best analogy? Inflation is like a
minute having fewer seconds.
One reason given for more central bankers releasing decisions publicly is that
monetary policy is more effective when households and businesses can understand and anticipate it.
If prices are not stable,
money becomes less useful as a store of value.
Over the long run if central banks want to avoid high rates of inflation, they need to be concerned with the
money growth rate.
People have a portfolio demand for money in part because
money is part of a well-diversified financial portfolio.
Trading risk faced by U.S. banks results from
moral hazard.
The velocity of M2 is
more volatile in the short run than the long run.
A bank's return on assets (ROA) is calculated by dividing the bank's
net profits after taxes by its assets.
If a bank sells off all of its assets and pays all of its liabilities, the amount remaining would be its
net worth.
Tom decides to withdraw $300 out of his checking account. The impact of this transaction on the Fed's balance sheet will be
no change in total assets or total liabilities, but an increase in the liability of currency and a decrease in the liability of reserves by $300, respectively.
Consider a $2 billion open market purchase of U.S. Treasury securities by the Federal Reserve. The banking system's balance sheet will specifically show
no net change in assets or liabilities, only a change in the composition of assets with securities decreasing and reserves increasing by $2 billion, respectively.
An open market sale of U.S. Treasury securities by the Fed will cause the banking system's balance sheet to show
no net change in assets or liabilities, only a change in the composition of assets with securities increasing and reserves decreasing.
The CAMELS ratings are
not made public.
Today, reserve requirements are
not often used as a direct tool of monetary policy.
When a business purchases a $50,000 computer system by writing a check, the business's balance sheet will
not reflect any increase in assets or liabilities, only a change in the composition of assets.
Banks do not hold a lot of their assets in the form of cash mainly because
of the opportunity cost of holding cash since cash does not earn interest.
The quantity of securities held by the Federal Reserve is controlled through
open market operations.
Ceteris paribus, when internal processes are inadequate or even fail, losses can occur that result from what type of risk?
operational risk
Seasonal credit provided by the Fed is not as common as it used to be because
other sources for long-term loans have developed for banks in these areas.
Banking regulations prevent banks from
owning common stocks of corporations.
Which one of the following best describes the payoff method used by the FDIC to address the insolvency of a bank? The FDIC
pays off the depositors up to the current $250,000 limit, so it is possible that some depositors will suffer losses.
To say monetary policy is transparent implies that
policy makers offer plausible explanations for their decisions along with supporting data.
The relationship between the velocity of money and interest rates is
positive but not stable.
Do depositors of a failed bank generally prefer that the FDIC use the "payoff method" or the "purchase-and-assumption method" for dealing with the failed bank? Depositors would:
prefer the purchase and assumption method since deposits over $250,000 will also be protected.
The reasons for the government to get involved in the financial system include each of the following, except which one?
preserve a bank's monopoly position
The primary objective of most central banks in industrialized economies is
price stability.
Many governments give their central bank control over issuing currency because
printing currency can be profitable for a government, providing a strong incentive to print too much.
Ceteris paribus, which one of the following business practices increases the possibility of a bank run? Banks
promise to satisfy withdrawal requests on a first-come, first-served basis.
In its role as the bankers' bank, a central bank performs each of the following except which one?
providing deposit insurance
Between 1970 and 2000, the Fed
published targets for money growth and rarely hit them.
If the market federal funds rate were below the target rate, the response from the Fed would likely be to
raise the IOER (interest rate on excess reserves).
Which one of the following incentives promotes more risk of moral hazard?
raising the deposit insurance limit
If the equation of exchange is MV = PY, the Y represents
real GDP.
A primary goal of central banks is to
reduce systematic risk.
Empirical data reveal the velocity of M2 to be
relatively stable in the long run.
Unconventional monetary policy tools include all of the following, except which one?
reserve requirement
Monetary policy operations for central banks are run through changes in which liability category?
reserves
As a portion of total assets measured in billions of dollars, the largest asset on the Fed's balance sheet is
securities.
If an investor thinks interest rates are likely to rise, ceteris paribus, she would
sell her bonds and hold more money.
The FOMC (federal open market comittee)
sets the target federal funds rate range.
Central banks are in a position to control risk in the economy because they control
short-term interest rates.
Primary credit extended by the Fed is
short-term, usually overnight loans.
The credit risk a bank faces is the risk resulting specifically from
some of the bank's loans not being repaid.
Credit unions are regulated by a combination of agencies, which includes
state authorities.
Forward guidance includes
statements today about policy targets in the future.
When a business purchases a $25,000 computer system by writing a check, the business's balance sheet will
still show the same total amount of assets as before the purchase.
Which type of government intervention would address market failures that exist in the area of cybersecurity by changing firms' incentives to allocate resources to promoting cybersecurity? Government should
strongly encourage disclosure and information sharing about breaches.
One argument for an independent central bank is that
successful monetary policy requires a long time horizon, usually well beyond the next election of most public officials.
For the European Central Bank (ECB), the equivalent of the FOMC's target federal funds rate is the
target refinancing rate.
In the period of 1979 to 1982, if the Fed had set an interest rate target that was equal to the actual market interest rates that occurred, the
target would not have been politically acceptable.
Which one of the following would be categorized as an unconventional monetary policy tool?
targeted asset purchases
In the United States, monetary policymakers
tend to have a long view while fiscal policymakers tend to ignore the long-run inflationary ramifications of their actions.
The efficient allocation of resources requires
that prices reflect the relative value of goods and services.
If the Federal Reserve is to be independent, then the quantity of securities it purchases must be determined by
the Federal Reserve itself.
The principal tool the Fed uses to keep the federal funds rate close to the target is
the IOER (interest rate on excess reserves).
Which one of the following regulates commercial banks as well as savings banks and savings and loans?
the Office of the Comptroller of the Currency
The ability to create money means the central bank can control
the availability of money and credit in a country's economy.
If your stockbroker gives you bad advice and you lose your investment,
the government will not reimburse you for the loss because you are not protected from bad advice by your stockbroker.
In the late 1970s and early 1980s, the velocity of money increased significantly. The main reason(s) for the increase was
the introduction of stock and bond mutual funds with draft writing privileges along with high nominal interest rates.
The higher the nominal interest rate
the less money individuals will hold for any given level of transactions and the higher the velocity of money.
Potential output depends on all of the following except which one?
the number of firms in the economy
Crises that occasionally hit financial markets will increase the demand for money since
the risk of holding money relative to other financial assets decreases.
One problem for the Federal Reserve regarding setting policy stems from the fact that
there are multiple goals that may be inconsistent with each other.
Central banks often find that
there are tradeoffs that make pursuing all of their goals simultaneously impossible.
The existence of a lender of last resort creates moral hazard for bank managers because
they have an incentive to take too much risk in their operations.
Consider the following graph. If the Fed increases the IOER from IOER Rate0 to IOER Rate1, they are implementing what type of policy?
tighter monetary controls where there is an increase in the rate at which banks are willing to lend
A good monetary policy instrument is
tightly linked to monetary policy objectives.
Which one of the following was not a goal of the Dodd-Frank Act of 2010?
to promote competition
A bank's reserves include
vault cash.
Using the equation of exchange, if real output and the money supply stay the same and the price level increases
velocity of money increases.
Key assumptions behind the quantity theory of money include that the
velocity of money is constant.
Central bank accountability means that central bankers
will report on the progress of goals that are established by politicians.
Given that velocity was more sensitive to an increase in the opportunity cost of holding money in the 1990s and 2000s as compared to the 1980s, using the relationship from the 1980s to make monetary policy in the 1990s
would not have produced the desired results.
Using the equation of exchange, if inflation is 1.5 percent, real output grows by 3.0 percent, and the growth rate of money is 5.0 percent, the change in the velocity of money is
−0.5 percent.
