Chapter 15- Federal Reserve and Open Market Conditions

Since 2008, excess reserves have increased from:

$2 billion to almost $3 trillion.

How does the Federal Reserve inject reserves into the banking system?

By creating new money it uses to buy financial assets

With quantitative easing, the Fed can now ____________.

Directly influence particular sectors of the economy

Which of the following is not a result of expansionary OMOs?

Less investment spending.

The Federal Reserve has the power to

Regulate banks Loan money to banks Increase the economy's money supply.

Which of the following is an important difference between repos and OMOs?

Repos are also conducted with other financial institutions besides banks.

Which of the following asset would be considered money?

an asset that can be easily converted into a widely-used means of payment with little loss in value

A reverse repurchase agreement will accomplish all of the following to banks and other financial intermediaries EXCEPT:

ensure their solvency.

Prior to 2008, a bank might have borrowed reserves from another bank because:

it kept its reserves too low and could not meet Fed requirements.

The problem of moral hazard exists when:

people or institutions, who are insured, tend to take on too much risk.

Economists have:

several different measures of the supply of money.

Traditionally, the Fed lends to:

solvent but illiquid banks.

In a "reverse repurchase agreement," the Fed:

takes on reserves in exchange for T-Bills.

When the Fed buys T-bills from banks:

the supply of bank reserves rises.

The Federal Reserve is powerful because it can influence _______ through its control over _______.

aggregate demand; the money supply

What is the intended effect of expansionary open market operations (OMOs)?

Increase in aggregate demand.

The Federal Deposit Insurance Corporation (FDIC) has the power to

Insure bank deposits.

In order to impact aggregate demand and the economy, the Fed needs to be able to influence:

M1 and M2

How long does it take for the rate to adjust when the Fed announces a change to its target for the federal funds rate?

Sometimes it adjusts before the Fed even takes any action.

In normal times, the actual money multiplier in the United States is:

approximately equal to 3.

The Fed conducts reverse repurchase agreements with:

banks and financial institutions other than banks.

When banks use the money they receive from deposits to make loans, they:

increase the money supply through the money multiplier.

If the Federal Reserve increases the minimum reserve ratio that private banks are required to hold, the following will occur:

The banks can make fewer loans and the money supply decreases.

What are the 3 common measures of the supply of money? What is included in each?

MB (monetary base) equals: currency + reserve deposits M1 equals: currency + checkable deposits M2 equals: M1 + savings deposits, money market mutual funds, and CD's (time deposits)

The tools of monetary policy:

continue to evolve as the economy changes.

In conducting quantitative easing, the Fed may decide to purchase mortgage securities to do all of the following EXCEPT:

influence average home prices.

The Fed's communication:

is itself an important tool of monetary policy.

Banking panics are especially dangerous because:

they can start easily and spread quickly.

Which of the following summarizes the limitations of monetary policy?

The Fed has a lot of control over just one interest rate, and interest rates influence economic activity in the short run only.

An increase in the rate of interest paid on reserves would be an example of:

contractionary policy that increases the demand for reserves and raises short-term interest rates.

Which of the following is not a reason that banks keep reserves?

To keep the interest rate from becoming too low.

What is quantitative easing?

When the Fed swaps money with banks for assets other than treasury bills.

What is one reason open market operations stopped being as effective during and after the Great Recession?

With interest rates near zero, it became nearly impossible to impact the economy by lowering the federal funds rate.

Economists typically define money as:

a widely accepted means of payment.

For a bank, "reserves" refers to:

the cash it keeps on hand to meet withdrawal requests.

An insolvent institution has:

liabilities that exceed its assets.

If the Federal Reserve sets the minimum reserve ratio for private banks at 25%, then the money multiplier is:

4

Reverse repurchase agreements are like temporary ___________.

Contractionary open market operations.

Over which aspect of the money supply does the Fed have the most direct control?

Monetary base

Which of the following count as money?

Money market mutual funds, currency, checkable deposits.

Deposit insurance guarantees that:

depositors will get their deposits back, even if the bank is insolvent.

The control the Federal Reserve has in manipulating the money supply by setting the minimum reserve ratio is limited because:

Banks can decide to hold more cash than the minimum reserve ratio requires AND People might not hold their money in banks, which limits the loanability of that cash.

What does a bank do with the money that you deposit?

Banks lend most of the money to people who want to borrow.

How does the Fed now influence how much banks hold in reserves?

By paying interest on reserves.

How much additional money will be created if you deposit a $200 check into your bank, which holds a 10% reserve ratio?

No money will be created since the $200 check does not represent an increase in reserves.

Which of the following best describes the monetary base?

Currency plus reserve deposits.

What is the intended effect of raising the federal funds rate?

Decrease in aggregate demand.

Are comic books money?

No, because selling a comic book takes work and provides an uncertain amount of funds.

Which of the following might lead banks to hold more reserves?

Fear that customers will want to withdraw most of their deposits

Prima Bank has the following characteristics: Short-term assets: $100M; Short-term liabilities: $120M; Total assets: $500M; Total Liabilities: $400M. Which type of bank is it?

Illiquid and solvent.

Contractionary OMOs are the reverse of expansionary OMOs and are intended to have the opposite effect. Which of the following should the Fed do to conduct contractionary OMOs?

Sell treasury bills to banks.

Which of the following did NOT happen during the 2008-09 financial crisis?

The Fed quickly raised interest rates to stop the flow of easy credit.

Are checking accounts money?

Yes, because checking accounts can be used to buy goods and services.

Are saving accounts money?

Yes, even though they technically can't be used to buy goods and services

The Fed may also lend to insolvent banks, rather than winding them down, in order to:

address the problem of systemic risk.

Why didn't the huge increase in the money supply that resulted from quantitative easing lead to increases in inflation?

because quantitative easing increased the monetary base, but not broader definitions of money like M1 and M2

If the Fed wanted to use open market operations to reduce interest rates, it would:

buy T-bills from banks.

For the most part, prior to 2008, banks typically held:

excess reserves equal to less than 1% of deposits.

High-value, long-term projects benefit from:

long-term relationships between lenders and borrowers.

Quantitative easing involves the Fed swapping:

money for assets other than T-bills.

The _______ tells us how many additional dollars of deposits are created with each additional dollar of reserves.

money multiplier, calculated as 1 divided by the reserve ratio,

Large banks in the United States:

must keep at least 10% of deposits in reserve.

During the Great Recession, the Fed relied on each of the following tools to influence the economy EXCEPT:

open market operations.

What is included in MB that is not included in either M1 or M2?

reserve deposits

In the "old days" (prior to 2008), the Fed typically conducted monetary policy by:

targeting the federal funds rate with open market operations.

If people hold onto some money as cash, rather than depositing it into banks:

the money multiplier will be smaller.

If a bank customer deposits $100 in cash, and the bank lends $90 of that deposit to another customer by crediting $90 to her account:

the money supply has increased by $90.

The Fed acts as lender of last resort:

when deposit insurance isn't enough or when an institution isn't covered by deposit insurance.

An illiquid asset is one that is _______ but _______.

worth a lot in the future; can only be sold today at a low price