Quiz #8

Given that the marginal benefit a bank derives from holding excess reserves is the reduction in the risk of suffering a reserve deficiency and that the marginal costs is the loss of interest income the bank incurs from its resulting inability to invest in an interest earning asset, the optimal level of excess reserves should be the level at which the marginal benefit exceeds the marginal costs. T/F

False

Which of the following is NOT consistent with expansionary monetary policy? an increase in borrowed reserves a reduction in the required reserve ratio increases in the federal funds rate an increase in nonborrowed reserves

increases in the federal funds rate

All of the following arguments are presented in favor of inflation targeting EXCEPT that it would provide an anchor for inflationary expectations. it would reduce the lags inherent in monetary policy. it would draw attention to what the central bank can achieve in practice. it would promote accountability by providing a yardstick by which policy can be measured.

it would reduce the lags inherent in monetary policy.

Which of the following is the least accurate statement about reserve deficiencies? Reserve deficiencies are costly primarily because banks that encounter reserve deficiencies are unable to make profitable loans. The probability that any given bank will experience a reserve deficiency is negatively correlated with its excess reserve ratio. Banks' precautionary demand for excess reserves reflects their desire to mitigate the risk of encountering costly reserve deficiencies. During any given time period, unexpectedly high withdrawals relative to deposits can lead to unintended depletion of banks' reserves and to costly reserve deficiencies.

Reserve deficiencies are costly primarily because banks that encounter reserve deficiencies are unable to make profitable loans.

Which of the following is not an attribute of monetary policy regimes in which the monetary authority practices interest rate targeting? The monetary authority believes there is a reliable relationship between the interest rate it chooses to target and ultimate policy objectives like stable prices and full employment. The monetary authority directly targets a long-term interest rates since it wants to influence demand for interest sensitive goods which depends on longer term interest rates. The money supply is subservient to the monetary authority's interest rate target in the sense that the monetary authority sets a value for its interest rate target and implements whatever changes in reserves and the monetary base that are needed to achieve the desired value of its interest rate target. The monetary authority targets a very short-term interest rate despite the fact that it ultimately wants to affect demand for interest sensitive goods which depend on longer term interest rates.

The monetary authority directly targets a long-term interest rates since it wants to influence demand for interest sensitive goods which depends on longer term interest rates.

Let iff represent the federal funds rate, id represent the discount rate, and iioer represent the interest rate the Fed pays banks on their excess reserve balances at the Fed. The diagram below illustrates the demand curve for reserves in the federal funds market. Which of the following statements is the most accurate and complete explanation for the downward sloping segment (i.e. the segment BC) of the demand curve for reserves in the federal funds market? The opportunity costs of holding excess reserves is equal to ( iioer - iff ) and is an appropriate measure of the marginal costs of holding excess reserves. The marginal benefit of holding excess reserves is the reduction in the costs of reserve deficiency due to the mitigation of the risk of such deficiencies occurring. Holding all else constant, the marginal or opportunity costs of holding excess reserves decreases as iff falls towards iioer. This reduces marginal costs relative to marginal benefit and induces optimizing banks -- who hold the level of excess reserves at which marginal cost is just equal to marginal benefit -- to increase their demand for excess reserves. The opportunity costs of holding excess reserves is equal to ( iff - iioer ) and is an appropriate measure of the marginal costs of holding excess reserves. The marginal benefit of holding excess reserves is the reduction in the costs of reserve deficiency due to the mitigation of the risk of such deficiencies occurring. Holding all else constant, the marginal or opportunity costs of holding excess reserves increases as iff falls towards iioer. This reduces marginal costs relative to marginal benefit and induces optimizing banks -- who hold the level of excess reserves at which marginal cost is just equal to marginal benefit -- to reduce their demand for excess reserves. The opportunity costs of holding excess reserves is equal to ( iioer - iff ) and is an appropriate measure of the marginal benefit of holding excess reserves. The marginal benefit of holding excess reserves is the reduction in the costs of reserve deficiency due to the mitigation of the risk of such deficiencies occurring. Holding all else constant, the marginal benefit of holding excess reserves increases as iff falls towards iioer. This reduces marginal costs relative to marginal benefit and induces optimizing banks -- who hold the level of excess reserves at which marginal cost is just equal to marginal benefit -- to increase their demand for excess reserves. The opportunity costs of holding excess reserves is equal to ( iff - iioer ) and is an appropriate measure of the marginal costs of holding excess reserves. The marginal benefit of holding excess reserves is the reduction in the costs of reserve deficiency due to the mitigation of the risk of such deficiencies occurring. Holding all else constant, the marginal or opportunity costs of holding excess reserves decreases as iff falls towards iioer. This reduces marginal costs relative to marginal benefit and induces optimizing banks -- who hold the level of excess reserves at which marginal cost is just equal to marginal benefit -- to increase their demand for excess reserves.

The opportunity costs of holding excess reserves is equal to ( iff - iioer ) and is an appropriate measure of the marginal costs of holding excess reserves. The marginal benefit of holding excess reserves is the reduction in the costs of reserve deficiency due to the mitigation of the risk of such deficiencies occurring. Holding all else constant, the marginal or opportunity costs of holding excess reserves decreases as iff falls towards iioer. This reduces marginal costs relative to marginal benefit and induces optimizing banks -- who hold the level of excess reserves at which marginal cost is just equal to marginal benefit -- to increase their demand for excess reserves.

Which of the following is the best explanation for the vertical portion of the supply curve for total reserves? The supply of total reserves at any given level of the federal funds rate is equal to reserves borrowed at the discount window. However, when the discount rate is greater than the prevailing federal funds rate, banks will prefer to borrow reserves from other banks. Therefore, when the federal funds rate is less than the discount rate, reserves borrowed at the discount window will be equal to zero and total reserves will be equal to zero. The supply of total reserves at any given level of the federal funds rate is equal to non-borrowed reserves plus reserves borrowed at the discount window. However, when the discount rate is less than the prevailing federal funds rate, banks will prefer to borrow reserves from other banks. Therefore, when the federal funds rate is greater than the discount rate, reserves borrowed at the discount window will be equal to zero and total reserves will be equal to non-borrowed reserves. The supply of total reserves at any given level of the federal funds rate is equal to non-borrowed reserves plus reserves borrowed at the discount window. However, when the discount rate is greater than the prevailing federal funds rate, banks will prefer to borrow reserves from other banks. Therefore, when the federal funds rate is less than the discount rate, reserves borrowed at the discount window will be equal to zero and total reserves will be equal to non-borrowed reserves. The supply of total reserves at any given level of the federal funds rates is equal to non-borrowed reserves plus reserves borrowed at the discount window. However, when the discount rate is greater than the prevailing federal funds rate, banks will prefer to borrow reserves from other banks. Therefore, when the federal funds rate is less than the required reserve ratio, reserves borrowed at the discount window will be equal to zero and total reserves will be equal to non-borrowed reserves.

The supply of total reserves at any given level of the federal funds rate is equal to non-borrowed reserves plus reserves borrowed at the discount window. However, when the discount rate is greater than the prevailing federal funds rate, banks will prefer to borrow reserves from other banks. Therefore, when the federal funds rate is less than the discount rate, reserves borrowed at the discount window will be equal to zero and total reserves will be equal to non-borrowed reserves.

Despite the fact that the federal funds rate is a market determined rate, the Fed is able to use its monetary policy tools to influence the federal funds rate. Which of the following statements is the most accurate and complete explanation of how the Fed exerts upward and/or downward pressure on the federal funds rate? When the Fed wants to exert downward pressure on the federal funds rate, it extracts reserves from the banking system by conducting open market purchases which causes excess demand in the federal funds market, and thereby, an equilibrating decline in the federal funds rate. Alternatively, when the Fed wants to exert upward pressure on the federal funds rate, it injects reserves into the banking system by conducting open market sales, which causes excess supply in the federal funds market, and thereby, an equilibrating rise in the federal funds rate. When the Fed wants to exert upward pressure on the federal funds rate, it extracts reserves from the banking system by conducting open market sales which causes excess demand in the federal funds market, and thereby, an equilibrating rise in the federal funds rate. Alternatively, when the Fed wants to exert downward pressure on the federal funds rate, it injects reserves into the banking system by conducting open market purchases, which causes excess supply in the federal funds market, and thereby, an equilibrating decline in the federal funds rate. When the Fed wants to exert upward pressure on the federal funds rate, it extracts reserves from the banking system by conducting open market purchases, which causes excess supply in the federal funds market, and thereby, an equilibrating rise in the federal funds rate. Alternatively, when the Fed wants to exert downward pressure on the federal funds rate, it injects reserves into the banking system by conducting open market sales, which causes excess demand in the federal funds market, and thereby, an equilibrating decline in the federal funds rate. When the Fed wants to exert upward pressure on the federal funds rate, it extracts reserves from the banking system by conducting open market purchases, which causes excess demand in the federal funds market, and thereby, an equilibrating rise in the federal funds rate. Alternatively, when the Fed wants to exert downward pressure on the federal funds rate, it injects reserves into the banking system by conducting open market sales, which causes excess supply in the federal funds market, and thereby, an equilibrating decline in the federal funds rate.

When the Fed wants to exert upward pressure on the federal funds rate, it extracts reserves from the banking system by conducting open market sales which causes excess demand in the federal funds market, and thereby, an equilibrating rise in the federal funds rate. Alternatively, when the Fed wants to exert downward pressure on the federal funds rate, it injects reserves into the banking system by conducting open market purchases, which causes excess supply in the federal funds market, and thereby, an equilibrating decline in the federal funds rate.

Suppose heavy losses make banks more cautious and they increase their demand for excess reserves, the Fed can counteract the effect of this change on the federal funds rate by conducting open market purchases to reduce the supply of reserves. conducting open market sales to increase the supply of reserves. conducting open market purchases to increase the supply of reserves. conducting open market sales to reduce the supply of reserves.

conducting open market purchases to increase the supply of reserves.

According to Taylor's rule, all of the following variables help explain the behavior of the federal funds rate EXCEPT the inflation gap. the yield curve. current inflation. the output gap.

the yield curve.