ECO 324- Final
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.
Suppose a bank faces a gap of 20 between its interest-sensitive assets and its interest-sensitive liabilities. What would happen to bank profits if interest rates were to fall by 1 percentage point? You should report your answer in terms of the change in profit per $100 in assets.
A gap of 20 means that the bank has more interest-sensitive assets than liabilities. When interest rates fall, therefore, bank profits will fall because the bank loses more by paying less on its assets than it gains from receiving less on its liabilities. The gap of 20 implies that profits will rise by 20 cents per $100 of assets.
Assuming that they could, which of the following types of government do you think would be more likely to pursue policies, such as forcing the central bank to buy its bonds in order to finance spending, that would seriously hinder the central bank's pursuit of low and stable inflation?
A government of a politically unstable country who is heavily indebted and considered an undesirable borrower in international markets.
What is the difference between solvency and liquidity for a bank?
A solvent bank has a positive net worth while a bank with liquidity means that the bank has sufficient reserves and immediately marketable assets to meet withdrawal demands.
The conventional Taylor rule [Target federal funds rate = Natural rate of interest + Current inflation + ½ (Inflation gap) + ½ (Output gap)] places weights of one-half on the inflation gap and output gap, corresponding to the "dual mandate" of the U.S. central bank. Taking into account what you know about the policy goals of the ECB, how might you amend the Taylor Rule to better approximate policymaking behavior by the ECB?
A weight on the inflation gap greater than 1/2 may be more appropriate in the ECB's case. However, the central bank is sensitive to output fluctuations, so the weight on the inflation gap should remain less than 1.
Currently, all the national central banks in the Eurosystem are involved with the implementation of monetary policy. What do you think the advantage would be of centralizing the conduct of these day-to-day interactions with financial markets at the ECB in Frankfurt? Are there any disadvantages you can think of?
An advantage might be that centralizing the implementation of monetary policy would be less cumbersome than conducting these interactions at 19 different national central banks. A possible disadvantage would be the loss of local market knowledge.
Which do you think would be more harmful to the economy?
An inflation rate that averages 12 percent a year and has a high standard deviation. The less predictable inflation is, the more it distorts economic decisions and the more systematic risk it creates.
Which do you think would be more harmful to the economy?
An inflation rate that averages 5 percent a year and has a high standard deviation.
Explain the mechanics of a speculative attack on the currency of a country with a fixed exchange rate regime.
Assume that Country A has a fixed exchange rate, and that its central bank holds a specific volume of foreign currency reserves. Investors come to believe that Country A will have to let its currency depreciate Correct. To benefit from the prospective change in the currency's value, investors borrow that currency in the country's financial market and take the proceeds of the loan to the central bank to exchange them for some other currency (normally, the U.S. dollar, euro, or yen). If this process happens on a large scale, the central bank will deplete its foreign currency reserves, and be forced to devalue its currency or abandon its fixed exchange rate entirely. Knowing that the central bank has limited foreign exchange resources, investors can put great pressure on the central bank of Country A. Once the currency's value has been changed by the central bank, the investors repay their loans with the depreciated currency for an overall gain.
Why were runs during the financial crisis of 2007-2009 not limited to institutions with large exposures to subprime mortgage lending?
Banks and shadow banks are highly interconnected with one another and so problems in one institution can quickly spread to others, making otherwise healthy institutions vulnerable.
Why do you think bank managers are not always willing to pursue strategies to reduce the fragility of their institutions?
Banks usually pay relatively low interest rates on demand deposits and earn relatively low interest rates on more liquid assets. Strategies to reduce fragility are likely to reduce profit margins.
The Maastricht Treaty, which established the European Central Bank, states that the governments of the countries in the euro area must not seek to influence the members of the central bank's decision-making bodies. Why is freedom from political influence crucial to the ECB's ability to maintain price stability?
Because politicians are elected for short terms, they have an incentive to create short-term prosperity at the expense of future inflation. If they can influence the central bank, they will push for expansionary monetary policy that increases economic growth in the short run but leads to inflation in the long run.
When the values of stocks and bonds fluctuate, they have an impact on the balance sheets of insurance companies. Why is that impact more likely to be a problem for life insurance companies than for property and casualty insurance companies?
Because property and casualty insurance companies are likely to have to make a large number of payments in the near future, they invest primarily in short-term assets, like money market instruments. Payments from life insurance companies occur in the distant future, so they invest in long-term instruments, predominantly stocks and bonds. Life insurance companies face the risk that they will have to sell these assets when prices are low in order to pay policyholders' claims.
Federal Reserve buying of mortgage-backed securities is an example of a targeted asset purchase. Explain how the Fed's actions are intended to work.
By purchasing mortgage-backed securities (MBS), the Fed sought to lower mortgage rates in order to increase home sales, raise house prices, and promote housing construction.
Core Principle 3 states information is the basis for decisions. Suggest one way in which the problems associated with the shadow banking sector during the 2007−2009 financial crisis could be mitigated in the future.
Create regulations that require the disclosure of certain standard information about shadow banking activities to investors and trading partners.
Deflation is the rate of decline in the aggregate price level. Why might unexpected deflation be of particular concern to someone managing a bank?
Deflation is associated with falling net worth of borrowers, as the nominal value of their assets fall but the dollar amount of their liabilities does not. This can lead to reduced lending as asymmetric information problems worsen and the associated downturn in economic activity can increase defaults. This, in turn, leads to a deterioration in the quality of the bank's balance sheet and may eventually lead to insolvency.
Follow the impact of a $100 cash withdrawal through the entire banking system, starting with a bank called Bank A, assuming that the reserve requirement is 10 percent and that banks have no desire to hold excess reserves.
Deposits fall by $100 and reserves fall by $100. Bank A needs to increase its reserves by $90 in order to meet the required reserve ratio. In order to do so, Bank A will sell $90 of securities to a customer of Bank B. The deposit account of the person who purchased the securities will fall by $90, as will the reserve balance of his bank, Bank B. Bank B now needs to increase its reserves by $81 in order to meet the reserve requirements so it will sell $81 of securities. This continues until deposits contract by $100/0.1 = $1,000.
Explain how an incomplete understanding at the Federal Reserve of the relationship between the central bank's balance sheet and the money supply contributed to the Great Depression.
During the Great Depression, the central bank was increasing the monetary base at a significant rate. Conditions in the economy and the banking system, however, meant that the money multiplier was declining, so the overall impact was a fall in the quantity of money. This contributed to the contraction of the economy.
Suppose you are advising a bank on the management of its balance sheet. In light of the financial crisis of 2007-2009, what arguments might you make to convince the bank to hold additional capital?
During the financial crisis of 2007-2009, many banks failed and many more would have in the absence of government support. Holding additional capital will help avoid failure in the future by reducing risk of insolvency.
Suppose you receive the following information about two inflation-targeting economies: Economy A has been volatile historically, with the unemployment rate fluctuating widely around the natural rate, and the neutral real interest rate estimated to be around 1.5 percent. Despite the economic volatility, the well-designed central bank has enjoyed many decades of credibility. Economy B has seen unemployment rates stay relatively close to the natural rate with the neutral real interest rate estimated to be around 3 percent. Despite the stable unemployment rate, the credibility of the central bank is somewhat fragile. Based on this information and assuming all other things are equal, which economy would be more likely to need the use of unconventional policy tools?
Economy A. The low neutral rates and high unemployment volatility increase the probability of needing to use unconventional policy tools.
Explain the link between falling house prices and bank failures during the financial crisis of 2007-2009.
Falling house prices led to a higher rate of mortgage defaults (as some customers could not re-finance to a lower interest rate as they had planned, for example). These mortgage defaults, along with falling values of mortgage-backed securities held by banks, reduced the value of bank assets and so lowered bank capital. (Recall that bank capital is the difference between the value of its assets and liabilities.) In some cases, bank capital was wiped out and so the bank failed.
Suppose the central bank in your country has price stability as its primary goal. Faced with a choice of having monetary policy decisions made by a well-qualified individual with an extremely strong dislike of inflation or a committee of equally well-qualified people with a wide range of views, which choice would you recommend?
Having monetary policy decisions made by a committee of equally well-qualified people with a wide-range of views.
Bank Y and Bank Z both have assets of $1 billion. The return on assets for both banks is the same. Bank Y has liabilities of $950 million while Bank Z's liabilities are $850 million. In which bank would you prefer to hold an equity stake?
If both banks have $1 billion in assets and have the same return on assets, then net profit after taxes must be the same for the two banks. Bank Y has bank, or equity, capital of $50 million while Bank Z has equity capital of $150 million, so the return on equity is lower for Bank Z.Bank Z has a lower leverage ratio than Bank Y; however, a higher portion of its assets is financed from nonborrowed funds. Therefore, Bank Z represents a safer investment.
How did the Fed's behavior during the financial crisis of 2007-2009 illustrate that it had learned a valuable lesson from the Great Depression?
In contrast, when a similar decline in the money multiplier (due to a surge in demand for excess reserves) emerged during the financial crisis of 2007-2009, the Fed rapidly expanded the supply of reserves, preventing a collapse of the money supply like that seen in the 1930s.
Suppose in an election year, the economy was declined into a recession. At the same time, clear signs of inflationary pressures were apparent. How might the central bank with a primary goal of price stability react? How might members of the incumbent political party who are up for reelection react?
In this case, the appropriate monetary policy is to tighten monetary policy, increasing interest rates to curb the emerging inflationary pressures in pursuit of the long-run goal of price stability. In contrast, it is likely that the politicians due for reelection would be more concerned with the recession in the economy and be in favor of a cut in interest rates. In the absence of influence over an independent central bank, they may push for immediate increases in government spending or reductions in taxes.
Suppose in an election year, the economy started to slow down. At the same time, clear signs of inflationary pressures were apparent. How might the central bank with a primary goal of price stability react? How might members of the incumbent political party who are up for reelection react?
In this case, the appropriate response is to tighten monetary policy, increasing interest rates to curb the emerging inflationary pressures in pursuit of the long-run goal of price stability. It is likely that the politicians due for reelection would be more concerned with the slowdown in the economy and would be in favor of a cut in interest rates. In the absence of influence over an independent central bank, they may push for immediate increases in government spending or reductions in taxes.
Has the distinction between direct and indirect forms of finance become more or less important in recent times? Why?
Less important. The increasing sophistication of the financial system has led to greater institutionalization, so that even direct finance transactions usually involve a financial institution to some extent.
Explain why financial institutions such as pension funds and insurance companies are not as vulnerable to runs as money market mutual funds and securities dealers.
Like deposit-taking institutions, money market mutual funds and securities dealers have liquid liabilities backing illiquid assets and can suffer from a loss of liquidity similar to a deposit withdrawal from a bank at any time. In contrast, liability holders of pension funds and insurance companies cannot withdraw funds whenever they want. Therefore, even though their assets tend to be illiquid, they are not as vulnerable to runs.
Why do you think the Fed maintains 12 voting members on the Federal Open Market Committee?
Maintaining the 12 members helps ensure that no one individual has too much authority.
Assuming the country is open to international capital flows, which of the following combinations of monetary and exchange-rate policies are viable? Option a: A domestic interest rate as a policy instrument and a floating exchange rate. Option b: A domestic interest rate as a policy instrument and a fixed exchange rate. Option c: The monetary base as a policy instrument and a floating exchange rate.
Options a and c are both viable. They combine independent domestic monetary policy with a floating exchange rate and so are feasible options with international capital mobility.
Assuming the country is open to international capital flows, which of the following combinations of monetary and exchange-rate policies are viable? Option i: The monetary base as a policy instrument and a floating exchange rate. Option ii: A domestic interest rate as a policy instrument and a floating exchange rate. Option iii: A domestic interest rate as a policy instrument and a fixed exchange rate.
Options i and ii are both viable. They combine independent domestic monetary policy with a floating exchange rate and so are feasible options with international capital mobility.
Do you think the FOMC has an easier or a harder time agreeing on monetary policy than the Governing Council of the ECB? Why?
The FOMC will have an easier time agreeing on monetary policy. The FOMC and ECB have similar numerical inflation objectives. However, the presence of national biases may make agreement among members of the FOMC Governing Council of the ECB more difficult. By contrast, the Federal Reserve has very little regional bias. Also, a group of 12 (the number of voting FOMC members) is likely to have an easier time coming to a decision than a group of 25 (the current number of ECB Governing Council members).
In 2012, the Federal Reserve joined many other central banks by making explicit a numerical target for inflation. Explain how stating that an annual inflation rate of 2 percent over the long run is most consistent with its mandate can help the Federal Reserve fulfill that mandate.
The Federal Reserve stating its objective explicitly can help anchor inflationary expectations. A credible central bank will be expected to alter policy in the future to keep inflation near its target. Announcing the target raises the cost of reneging on the central bank's commitment to price stability, making the policy time consistent. As inflation expectations inform firms' pricing and wage decisions, stabilizing inflation expectations around 2 percent prevents actual inflation from deviating too far from this level for long, thus helping the achieve the goal of price stability.
Suppose you examine the central bank's balance sheet and observe that since the previous day, reserves had risen by $400 million. In addition, on the asset side of the central bank's balance sheet, securities had risen by $400 million. What activity did the central bank carry out earlier in the day to lead to these changes in the balance sheet? Do you think by carrying out this activity the central bank was aiming to increase, decrease, or maintain the size of the money supply?
The central bank conducted an open market purchase of $400 million with a commercial bank. The purchase of the securities would involve $400 million of securities being added to the central bank's balance sheet. The commercial bank would have received payment for the securities into its reserve account, thus leading to a rise of $400 million in reserves on the central bank balance sheet. By carrying out this activity, the central bank was aiming to increase the size of the money supply.
The long list of central bank goals includes the stability of interest rates and exchange rates. You look on the the central bank website and note that they have increased interest rates at every one of their meetings over the last year. You read the financial press and see references to how the exchange rate has moved in response to these interest-rate changes. How could you reconcile this behavior with the central bank pursuing its objectives?
The central bank faced a situation where increasing interest rates was necessary to curb emerging inflationary pressures and considered low and stable inflation a more important objective than interest-rate and exchange-rate stability.
A small eastern European economy asks your opinion about whether it should pursue the path to joining the European Economic and Monetary Union (EMU) or simply "euroize" (i.e., dollarize by using the euro for all domestic transactions). What advice would you give?
The economy should join the EMU rather than "euroize." Membership in the EMU would give the economy a say in monetary policy decisions and a share in the seignorage revenue from the printing of the euro.
How did the financial crisis of 2007-2009 affect the degree of concentration in the U.S. banking industry?
The level of concentration in the U.S. banking industry has increased. The top four commercial banks now account for about 40 percent of domestic deposits.
Use your knowledge of the problems associated with asymmetric information to explain why insurance companies often include deductibles as part of their policies.
The presence of deductibles helps to reduce moral hazard. In the case of car insurance, for example, the insured faces a cost associated with an accident and so will likely be more careful when driving.
What are the goals of the ECB? How are its officials held accountable for meeting them?
The primary goal of the ECB is to maintain price stability, which the ECB defines as an annual inflation rate of less than, but close to, two percent using the Harmonized Index of Consumer Prices. Like the Federal Reserve, the ECB is held accountable through releases of information, including its target interest rate, the explanatory statements that follow its meetings, regular reports to the European Parliament, frequent publications, and public speeches.
Suppose you have two deposits totaling $280,000 with a bank that has just been declared insolvent. Would you prefer that the FDIC resolve the insolvency under the "payoff method" or the "purchase and assumption" method?
The purchase and assumption method
When you withdraw cash from your bank's ATM, what happens to the size of the Fed's balance sheet? Is there any reason for the Fed to react to your action?
The reserves held by your bank at the Fed decline, but there is a larger volume of currency in the hands of the nonbank public. These changes are offsetting, so there is no impact on the Fed's total liabilities (or, equivalently, on the size of its balance sheet). However, your action has raised the currency-to-deposit ratio and can lead to a change in the money supply. The Fed may choose to alter policy to offset the impact on the money supply if the withdrawal is large enough.
In the absence of limits on the behavior of large intermediaries, how might the perception of institutions being "too-big-to-fail" lead to increased concentration in the banking industry?
The safety net creates moral hazard problems for big banks by encouraging extremely risky behavior. This puts small banks at a competitive disadvantage, driving them out of the market and leading to an increase in concentration.
The problems in the interbank lending market such as those seen during the 2007-2009 financial crisis would have affected your ability to take out a personal loan with a bank. Explain how.
The strains in the interbank market pushed up interbank lending rates, which increased the cost of funds to banks and would likely have lead to an increase in the rate on your personal loan. If your bank is having trouble obtaining short-term funding in the interbank market, it may decide to hold more cash and reduce lending, affecting your ability to secure a loan.
Why would current critics of fiat money urge governments to return to a gold standard?
They fear that governments will issue too much money.
Statistically, teenage drivers are more likely to have an automobile accident than adult drivers. As a result, insurance companies charge higher insurance premiums for teenage drivers. Suppose one insurance company decided to charge teenagers and adults the same premium based on the average risk of an accident among both groups. Using your knowledge of the problems associated with asymmetric information, explain whether you think this insurance company will be profitable.
This insurance company is unlikely to be profitable because of the problem of adverse selection. The insurance premium based on the average risk of an accident among both teenagers and adults will be higher than the premium for the relatively low-risk adults alone and lower than the premium for teenagers alone. Therefore, adults will not choose to be insured by this company, but teenagers will. The premium charged based on the average risk of teenagers and adults would not be sufficient to cover the claims of a teenage-only pool and so the company would not be profitable.
You are a bank examiner and have concerns that the bank you are examining may have a solvency problem. On examining the bank's assets, you notice that the loan sizes of a significant portion of the bank's loans are increasing in relatively small increments each month. What do you think might be going on and what should you do about it?
This may be a case where the bank has a large portion of nonperforming loans. When the loan payments are not made, the bank may be rolling the payment and associated interest costs into the principal of the loan, thus causing the loan size to increase incrementally.As an examiner, you need to establish which loans may eventually be repaid and which should be written off to assess the impact on the solvency of the institution.
"A central bank should remain vague about the relative importance it places on its various objectives. That way, it has the freedom to choose which objective to follow at any point in time." Assess this statement in light of what you know about good central bank design.
This statement is inaccurate. In order to be credible and to keep inflationary expectations under control, the central bank needs to communicate clearly its policy goals and the trade-offs between them.
You are a bank manager and have been approached by a swap dealer about participating in fixed for floating interest-rate swaps. If your bank has the typical maturity structure, which side of the swap might you be interested in paying and which side would you want to receive?
To hedge against the risk associated with short-term floating rate liabilities and longer-term fixed rate assets, the bank should pay fixed and receive floating in the interest-rate swap.
Explain why, in the absence of the time consistency problem, you might expect a central bank to be effective at holding the value of its domestic currency at an artificially low level, but not an artificially high level, for a sustained period.
To increase the value of its domestic currency, the central bank would have to sell foreign currency in exchange for domestic currency. The central bank can only continue to do this until it runs out of foreign exchange reserves. In contrast, in order to hold down the value of the domestic currency, the central bank would need to sell the domestic currency in return for foreign currency in the foreign-exchange market. As it is the monopoly supplier of the domestic currency, it can create as much of the domestic currency as it needs and so is likely to be able to pursue this latter policy for a longer period than the former. In the long run, however, the latter policy will lead to inflationary pressures in the economy.
Duration analysis is an alternative to gap analysis for measuring interest-rate risk. The percentage change in the market value equals −(duration of the bond) × (percentage-point change in the interest rate). Bankers compute the weighted-average duration of their liabilities and subtract it from the weighted-average duration of their assets to get a duration gap, which can be used to guide the bank's risk management strategy. The duration of an asset or liability measures how sensitive its market value is to a change in the interest rate: the more sensitive, the longer the duration. The longer the term of a bond, the larger the price change for a given change in the interest rate. Using this information and the knowledge that interest-rate increases tend to hurt banks, would you say that the average duration of a bank's assets is longer or shorter than that of its liabilities?
When interest rates increase, the market value of assets—such as bonds—will fall. If interest-rate increases tend to hurt banks, then the average value of assets must fall by more than the average value of liabilities. Given that duration is a measure of the sensitivity of an asset or liability's market value to a change in interest rates, this implies that the average duration of a bank's assets is longer than that of its liabilities.
You are the lender of last resort and an institution approaches you for a loan. You assess that the institution has $800 million in assets, mostly in long-term loans, and $600 million in liabilities. It is experiencing unusually high withdrawal rates on its demand deposits and is requesting a loan to tide it over. Would you grant the loan?
Yes. Based on the information given, you should grant the loan. The institution has positive net worth—its assets are greater than its liabilities—so it is solvent. It appears to be experiencing a short-term liquidity problem and a loan could prevent this otherwise healthy institution from failing.
Do you think the current policy of appointing members of the Board of Governors to staggered terms is consistent with the principles of good central bank design? Explain your answer.
Yes. Because they are appointed to staggered terms there will be more policy continuity which will enhance economic stability.
You are the lender of last resort and an institution approaches you for a loan. You assess that the institution has $200 million in assets, mostly in long-term loans, and $100 million in liabilities. The institution is experiencing usually high withdrawal rates on its demand deposits and is requesting a loan to tide it over. Would you grant the loan?
Yes. The institution has positive net worth but appears to be experiencing a short-term liquidity problem. A loan could prevent this otherwise healthy institution from failing.
A borrower seeking a mortgage today is often presented with the choice between a mortgage with an interest rate and monthly payment that stays fixed for the duration of the loan, or a mortgage with an interest rate and monthly payment that can change as other interest rates change. Typically the interest rate on the fixed-rate mortgage is higher. Having learned the five core principles, does this make sense?
Yes. The lender is shifting risk to the borrower. The risk here is that the lender agrees to a mortgage at (for example) 6% but then over the life of the loan (which can be 10, 25, even 30 years) interest rates in the market go up, putting the lender in the position of being "stuck" with the 6%. If the rate on the mortgage would change with market rates the lender would not have the risk. But remember, risk requires compensation, so to entice the borrower to take on the added risk the lender provides an inducement in the lower rate. A smart borrower will make the decision about whether or not the lower but changeable rate is a good decision based on information about interest rates (information, stability), and the decision may also depend on how long the borrower plans to live in the house (time).
Do you think the Federal Reserve successfully carried out its role as lender of last resort in the wake of the terrorist attacks on September 11, 2001?
Yes. The system was threatened by the inability to collect checks in the absence of civilian flights. The Fed stepped in and provided huge amounts of liquidity to enable banks to meet their commitments.
Suppose ECB officials ask your opinion about their operational framework for monetary policy. You respond by commenting on their success at keeping short-term interest rates close to target but also express concern about the complexity of their process for managing the supply of reserves. What specific changes would you suggest the ECB should make to its system in the future?
You might suggest that the ECB concentrate its operations in Frankfurt instead of having to coordinate these operations at all the national central banks simultaneously. You might also suggest that the ECB narrow the relatively long list of institutions that qualify as counterparties to open market operations and reduce the range of assets it accepts as collateral for these operations.
The central bank of a country facing economic and financial market difficulties asks for your advice. The bank cut its policy interest rate to the effective lower bound, but it was not low enough to stabilize the economy. Drawing on the actions taken by the Federal Reserve during the financial crisis of 2007-2009, what might you advise this central bank to do?
You should advise the central bank to use unconventional monetary policy tools such as quantitative easing, where aggregate reserves are provided beyond the level needed to lower the policy rate to zero, or credit easing, a policy in which the central bank alters the composition of its balance sheet. The central bank could also inform markets of its commitment to keep interest rates low (forward guidance).
In the first half of 1997, the Bank of Thailand maintained a fixed exchange rate of 26 Thai baht to the U.S. dollar, but Thai interest rates were substantially higher than those in the United States and Japan. Thai bankers were borrowing money in Japan and lending it in Thailand. a. Why was this transaction profitable? b. What risks were associated with this method of financing? c. Describe the impact of the change in value of the baht on the balance sheets of Thai banks involved in these transactions.
a. Bankers could borrow money in Japan at a low rate, and lend in Thailand at a high rate. b. There was the risk that the baht could depreciate, making it more costly to repay the money borrowed in Japan. In addition, there was risk that borrowers in Thailand could default on their loans. c. When the baht depreciated, the costs to the Thai banks of repaying their loans rose, which caused their reserves to shrink.
For each pair of instruments below, use the criteria for valuing a financial instrument to choose the one with the highest value: a. A U.S. Treasury bill that pays $1,000 in six months or a U.S. Treasury bill that pays $1,000 in three months. b. A U.S. government Treasury bill that pays $1,000 in three months or commercial paper issued by a private corporation that pays $1,000 in three months. c. An insurance policy that pays out in the event of serious illness or one that pays out when you are healthy, assuming you are equally likely to be ill or healthy.
a. The Treasury bill that pays out in three months because the sooner the payment, the more valuable. b. The Treasury bill is more valuable because the likelihood of the U.S. government honoring its debts is higher than a private corporation. c. The insurance policy that pays out when you are seriously ill, as this is when the payment is most needed.
Which of the following benefits would be observed with dollarization, and which would be observed with a monetary union? Earn revenue from money printing: Eliminate exchange-rate risk: Participate in monetary policy: Act as lender of last resort:
a. monetary union b. both monetary union and dollarization c. monetary union d. monetary union
Beginning in July of 2018, President Donald Trump openly and frequently criticized the Federal Reserve and its Chairman Jay Powell. Blatantly undermining the independence of the Fed in this way would likely
add a risk premium, driving down prices of U.S. assets.
Time consistency is critical for economic policy to be credible because
an effective policy is a strategy for the future, so it must be costly for policymakers to renege.
Banks serve essential functions in an economy, but their fragility arises from the fact that
banks provide liquidity to depositors.
The central bank has the ability to create money, which means that it
can impact the rate of inflation.
Investment banks
charge fees for advising clients for preparing new stock and bond issues for the market.
Operation Bernhard was a German operation to attack the United Kingdom by using
counterfeit British pounds.
Which one of the following would give the most importance to the goal of exchange rate stability?
emerging market countries where exports and imports are central to the structure of the economy
U.S currency is..
fiat money
Banks and insurance companies are examples of...
financial institutions
Since the 1920s, the ratio of assets to capital has more than doubled for commercial banks. Many economists believe this is the direct result of
government-provided deposit insurance.
The specific goals of central banks include all of the following except which one?
high stock prices
More of which one of the following is an important key to the financial system?
information
As a result of government-provided deposit insurance, the ratio of assets to capital for commercial banks since the 1920s has
just about doubled.
What matters most during a bank run is the
liquidity of the bank
During the financial crisis of 2007-2009 the U.S. Federal Reserve used its powers in all but which one of the following ways?
lowering bank reserve requirements
One thing that is true about economic policy in the United States is that
monetary and fiscal policy need not, but may, conflict.
Studying money and banking through five core principles is helpful because:
money and banking can undergo drastic changes overtime, but the five principles do not
In a sequence of nine steps between December 2015 and December 2018, the Federal Reserve increased its policy interest rate target range by 2.25 percentage points from a historically low level of close to zero. If central banks use interest rates to moderate business cycle swings in the economy, what might you infer from this decision about the Fed's view of the economy over this time period? The Federal Reserve's decision to incrementally increase the target for the policy interest rate from its historic low level reflected its view that an economic recovery was...
ongoing
In comparing money to a share of Microsoft stock held by an individual, we can say
only the money is a means of payment, but both are stores of value.
inflation refers to growth in an economy's
prices
Commercial banks
receive deposits in checking and savings accounts and use these funds to make loans.
Insurance companies
receive premium payments, which they invest in securities or other assets to earn income until claims are paid.
Pension funds
receive regular contributions from firms, invest these funds in long-term assets, and pay benefits to firms' retirees.
Implicit government support for "too-big-to-fail" banks
reduces the risk faced by depositors with accounts exceeding $250,000.
The introduction of money market substitutes for basic checking accounts was fueled partially by the...
relatively high rates of inflation that existed in the late 1970s and early 1980s
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.
You observe that two countries with a fixed exchange rate have current inflation rates that differ from each other. You check recent historical data and find that inflation differentials have been present in varying amounts for several months. How would you explain these observations in light of the theory of purchasing power parity? The theory of purchasing power parity (PPP):
tells us about the relationship between inflation rate differentials and exchange-rate movements over long periods of time. Month-to-month or year-to-year, there can be significant deviations from the theory.
The first phase of the Financial Crisis of 2007-08 began when
the French bank BNP Paribas suspended redemptions from three mutual funds invested in U.S. subprime mortgage debt.
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.
Which one of the following is not a pillar of the latest Basel Accord?
uniform international laws for bank regulation
The statement "risk requires compensation" implies that people..
will only accept risk when they are rewarded for doing so
Financial regulators
work to prevent monopolies but also work to prevent strong competition in banking.
