Money And Banking Test 2

Front 1

A thing for which someone is responsible, especially a debt or financial obligation

PROBLEM SET

Back 1

Liablility

Front 2

Asset

PROBLEM SET

Back 2

Property owned by a person or company, regarded as having value and available to meet debts, commitments, or legacies.

Front 3

Amount of currency in the hands of the non-bank public.

Back 3

Currency in Circulation

PROBLEM SET

Front 4

Reserves

PROBLEM SET

Back 4

The deposits in banks’ accounts at the Fed along with currency that the depository institutions are holding, typically called vault cash.

Front 5

The purchase or sale of bonds by the Fed. Purchases are referred to as open market purchases, whereas sales are referred to as open market sales.

Back 5

Open Market Operations

PROBLEM SET

Front 6

What is the Fed modeled after, and why was this?

PROBLEM SET

Back 6

Modeled from the US federal government, because most Americans are fearful of centralized power

Front 7

Central Bank, Banks, Depositors

Back 7

3 Agents in the Money Supply Process

PROBLEM SET

Front 8

How many Fed Banks are there?
How many on the Board of Governors?
How many FRB presidents have voting privileges on the FOMC?

Back 8

12
12 (7)
5

PROBLEM SET

Front 9

Considering our simplified balance sheets, what are the assets and liabilities of the Federal Reserve System? What are the assets and liabilities of the banking system?

PROBLEM SET

Back 9

Fed
A = securities and loans to financial institutions
L = currency in circulation and reserves

Banking System
A = reserves, securities, and loans
L = checkable deposits and discount loans

Front 10

Discount Loan

Back 10

A loan issued by a Federal Reserve bank to a member bank at an interest rate called the “discount rate.”

Front 11

National Banks

Back 11

Must be members of the Federal Reserve. (About 1/3 of total commercial banks)

Front 12

All Commercial Banks

Back 12

Now must keep the same amount (%) of required reserves at the Fed. Used to get no interest, now after 2006 get a little bit.

Could this hurt the recovery?

Front 13

Composition of the Board of Governors

Back 13

14 year terms to avoid political pressure. Chairman is 4 year renewable terms to get rid of him if needed.

Front 14

The interest rate on overnight loans from one bank to another

Back 14

Federal Funds Rate

Front 15

Who actually purchases the securities or sells in order to control money supply and interest rates?

Back 15

The Fed in New York

Front 16

Monetary policy instrument

Back 16

A variable that responds to the central bank’s tools and indicates the stance (easy or tight) of monetary policy.

Front 17

The ability of the central bank to set the goals of monetary policy.

Back 17

Goal Independence

Front 18

Case FOR Fed Independence

Back 18

Without it there could be an inflationary bias (political business cycle) to increase the money supply before an election

Could ignore long run stabilization policy

Politicians are rarely economists and therefore don’t understand the intricate balances of the economy.

Front 19

Case AGAINST Fed Independence

Back 19

1) Fed is undemocratic, elitist, hard to remove them
2) The Fed hasn't always been successful in its policy

Front 20

Required Reserves

Back 20

Reserves that the Fed requires
banks to hold.

Front 21

Additional reserves held by the bank

Back 21

Excess Reserves

Front 22

Borrowed Reserves (Loans to financial institutions)

Back 22

Liability for the financial institutions, but as an asset for the Fed

Front 23

Why should banks loan out as much money as possible?

Back 23

If there is no increase in checkable deposits it can loan out all of money from Fed. Holding excess reserves just earns the back a lower interest rate. Loan it out to the public and earn more!

Front 24

Formula for Multiple Deposit Creation (simple deposit multiplier)

Back 24

Deposits = Change in Reserves / rr%

This is when Fed puts in a $1, but we get way more in the system.

Front 25

MB = non borrowed MB + Borrowed reserves

Back 25

an increase in the nonborrowed monetary base will cause the money supply to increase as well.

Front 26

Money supply is related positively or negatively to the level of BORROWED RESERVES from the Fed?

Back 26

Positively

Front 27

Money supply is related positively or negatively to the REQUIRED RESERVE RATIO?

Back 27

Negatively

Front 28

Money supply is related positively or negatively to CURRENCY HOLDINGS?

Back 28

Negatively

Front 29

Money supply is related positively or negatively to EXCESS RESERVES?

Back 29

Negatively

Front 30

High Powered Money

Back 30

Money Supply (M) = multiplier (m) x MB

Front 31

money multiplier equation

Back 31

m = 1 + c / rr + e + c

if you put in $10 and m is 2.5, then $25 is created

Front 32

Money supply is related positively or negatively to an increase in the NON BORROWED MONETARY BASE?

Back 32

Positively

Front 33

The interest rate on overnight loans between member banks is called the?

Back 33

Federal Funds Rate

Front 34

How many of the Federal Reserve Bank Presidents vote on the Federal Open Market Committee (FOMC)?

Back 34

5

Front 35

1) Fed purchases $5 million from FNB
2) No excess reserves, RR% is 5%

Show the multiple deposit creation mechanism

Back 35

1) For the Fed, it adds $5 in securities (ASSETS) from FNB and $5 in reserves (LIABILITIES)

2) FNB loses $5 million in securities (ASSETS) but gains $5 in loans (ASSETS)

3) Bank A has $5 million in checkable deposits (LIABILITIES) and $.25 in reserves (ASSETS) and $4.75 million in loans (ASSETS)

Front 36

Federal Funds Rate

Back 36

The interest rate on overnight loans of reserves from one bank to another.

Front 37

Dual Mandate

Back 37

The Fed focuses on two goals, while other central banks may only focus on one.

For the Fed they are price stability and employment

Front 38

Multiple Deposit Creation

Back 38

If the Fed increases the money supply by $1, deposits increase by a multiple of $1

Front 39

Open Market Operations

Back 39

The buying and selling of bonds (govt securities) to increase or decrease the money supply

Front 40

Discount Rate

Back 40

The interest rate charged to a bank borrowing money from the Fed

Front 41

Repurchase Agreement
(Repo)

Back 41

A repo is where the Fed will purchase securities with the understanding that the seller will buy them back at some point in the near future

Front 42

Matched Sale-Purchase Transaction
(Reverse Repo)

Back 42

A reverse repo is where the Fed sells securities with the intent to buy them back at some point in the near future.

Front 43

Term Auction Facility

Back 43

New Fed tool to increase liquidity and get rid of stigma of buying from discount window. The rate purchased is usually below the discount rate.

Front 44

Nominal Anchor

Back 44

Something the Fed can control, it is a variable such as the inflation rate, which the Fed uses to anchor the the price level in order to get price stability

Front 45

1) Banking System has required reserve ratio of 5%
2) The FOMC agrees to buy $70 million of securities from FNB (Show the T Accounts)
3) How much has money supply increased?

Back 45

The MS has increased $70 / 0.05 = $1.4 billion

FNB loses $70 securities (ASSETS) but adds $70 in loans (ASSETS)

Bank A has reserves and loans in ASSETS based on the required reserves and what's left to loan and checkable deposits (LIABILITIES) that equal this.

And then it goes down to Bank B and Bank C with the same ratios in place.

Finally, the Fed has its securities, ASSETS go up $70 million and reserves LIABILITIES go up $70 million

Front 46

If a bank depositor withdraws $1,000 of currency from an account, what happens to reserves, checkable deposits, and the monetary base?

Back 46

1) Checkable deposits fall
2) Reserves fall for bank as it withdraws its same amount from Fed
3) However, the Monetary Base doesn't change because even though reserves go down, the person has this $1,000 of currency so the Fed's currency in circulation goes up $1,000

Front 47

What is the price of reserves in the banking system

Back 47

The opportunity cost of holding reserves instead of making loans with this money.

Front 48

How can Fed solve the zero lower bound issue?

Back 48

Fisher tells us that Rt = It - piEt

When It= 0 the only way to lower real interest rates is to increase future expectations of inflation

Front 49

During holiday season how could Fed combat the public hoarding of currency? What defensive operation could they use?

Back 49

They could repo, where they can inject money into the supply with a primary dealer. This helps to maintain target Federal Funds Rate.

Front 50

Explain Taylor Principle

Change in It > Change in piEt

f' (PIt) > 1

Back 50

We should adjust nominal interest rates by more than any change in the inflation rate.

If we DON'T do this then the real interest rate will move in the opposite direction of inflation, making the situation worse by FEEDING inflation.

Front 51

What are the 4 conventional monetary policy tools?

Back 51

D iscount Rate
O pen market operations
R equired Reserve Ratio
I nterest on Reserves

Front 52

Say there's a huge payment from Treasury to defense contractor. What defensive market operation can the Fed do?

Back 52

This could greatly effect the money supply. The Fed can temporarily decrease the money supply while this check clears (double counted) so the Fed could use a reverse repo to counter this temporary increase where they sell bonds to a primary dealer who will soon buy them back.

Front 53

Why are the demand and supply curves in the market for reserves sloped and why are both kinked?

Back 53

For supply curve, once the federal funds rate reaches the discount rate the line becomes horizontal, where its' cheaper to borrow from Fed rather than each other through overnight loans

For demand, quantity demanded depends on price. Quantity demanded falls when FFR increases because FFR is the opportunity cost of holding reserves. It flattens when FFR is below reserve rate causes bank to hold onto their reserves because they earn more then.

Front 54

If a bank sells $10 of bonds to Fed to pay back $10 it owes, what is the effect on checkable deposits?

Back 54

There is no change, they are only swapping assets, there are no changes in reserves

Front 55

Can Fed perfectly control the amount of reserves in the system?

Back 55

No, it can only control the amount of non borrowed reserves. Since they are lender of last resort they have to provide discount loans when asked, even though they can set the interest rate on these loans.

Front 56

What happens to demand for reserves when FFR increases?

Back 56

The opportunity cost of holding reserves increases, and the quantity demanded falls.

Front 57

Dynamic Open Market Operations

Back 57

Intended to change the level of reserve and the monetary base during
normal times.

Front 58

Defensive Open Market Operations

Back 58

Intended to offset
changes in other factors that might disrupt the
targeted interest rate or money supply.

Front 59

Fed as lender of last resort

Back 59

This alone has helped to quell bank panics, although some banks took huge risks during financial crisis knowing the Fed would give them money if need be.

Front 60

Zero Lower Bound

Back 60

We can always earn more holding some kind of security instead of cash, so nominal interest rate can't be negative.

Front 61

Time Inconsistency Problem

Back 61

Monetary policy that is conducted on a discretionary, day-by-day basis, leading to poor long run outcomes.

Plan for the long run, don't hurt growth by injecting uncertainty.

Front 62

Advantages of Inflation Targeting

Back 62

I ncreased Accountability
E asy to understand

The two advantages outweigh the four negatives. Low and stable inflation is KEY

Front 63

Disadvantages of Inflation Targeting

Back 63

L ow economic growth
O utput fluctuations
R igidity
D elayed signaling