Exam 3 Review

• Assets on the Fed's balance sheet include:

  government securities and discount loans
• An open market purchase of securities by the Fed will:

  have no effect on assets of the nonbank public but increase assets of the Fed.
• The federal funds rate is

  the interest rate on loans of reserves from one bank to another.
• Holding everything else constant, if the federal funds rate falls, then the demand for

  excess reserves rises because they have a lower cost
• The supply curve for reserves is ________ when the federal funds rate is below the discount rate and ________ when the federal funds rate is above the discount rate.

  vertical; horizontal
• Under usual circumstances, an increase in the discount rate causes

  no change in the federal funds rate
• If the Fed increases reserve requirements, the demand for reserves _______ and the equilibrium federal funds rate ________.

  increases; rises
• If the Federal Reserve wants to expand reserves in the banking system, it will

  purchase government securities.
• During the 2007-2009 financial crisis, what actions did the Fed take to limit the scope of the crisis?

  The Fed lowered the spread on the discount rate to 50 basis points, and then to 25. The Fed set up the Term Auction Facility to provide further liquidity to banks. The Fed purchased assets of Bear Stearns to facilitate the purchase of Bear Stearns by J.P. Morgan.
• The minimum federal funds rate

  is the interest rate paid on reserves.

  is set due to demand for excess reserves.
• The maximum federal funds rate is

  set by arbitrage.
• An open market purchase

  shifts the supply curve for reserves to the right and causes the federal funds rate to fall.
• Quantitative easing and credit easing are essentially the same thing. T/F

  False
• The European Central Bank uses main refinancing operations as the predominant form of open market operations, which are similar to the Fed's repo transactions. T/F

  True
• Price stability is defined by central bankers as low and stable inflation. T/F

  True
• In the long run, no inconsistency exists between the price stability goal and other goals, such as high unemployment.

  True
• In the short run, price stability often conflicts with the goals of high employment and interest-rate stability. T/F

  True
• Central bank officials exclusively focus on interest-rate stability when discussing monetary policy objectives. T/F

  False
• If the Fed wants to temporarily drain reserves from the banking system, it will engage in

  a matched sale-purchase transaction.
• Inflation targeting involves

  an information-inclusive approach in which many variables are used in making decisions about monetary policy.

  increased accountability of the central bank for attaining its inflation objectives.

  a public announcement of medium-term numerical targets for inflation.
• Which type of open market operation is intended to change the level of reserves?

  Dynamic open market operations
• Credit-driven asset bubbles are particularly dangerous. When asset prices fall, the deleveraging of credit markets reduces economic activity. T/F

  True
• Bubbles driven solely by irrational exuberance lead to a failure of financial institutions. T/F

  False
• Why the Fed should NOT try to pop bubbles (Greenspan Doctrine).

  It's better to control the after-effects of a burst bubble.

  Bubbles are nearly impossible to identify.

  Monetary policy affects many segments of the economy, and can't be targeted to only impact one area.

  An increase in interest rates may have no effect on the bubble.
• Why the Fed SHOULD try to pop bubbles.

  Macroprudential regulation can be used to control credit-driven bubbles.

  Credit-driven asset-price bubbles are easier to identify.

  Credit-driven asset-price bubbles have a much stronger effect on the economy.
• If the Fed wants to "prick" an asset-pricing bubble driven by a credit boom, what is the primary tool for accomplishing this?

  Raising interest rates
• Price stability is desirable because

  inflation creates uncertainty, making it difficult to plan for the future.
• Select all that are correct, concerning price stability as a monetary goal.

  In the short run price stability often conflicts with the goals of high employment and interest-rate stability. In the long run, no inconsistency exists between the price stability goal and the other goals, such as high unemployment.
• The Fed puts price stability along with maximum employment as its primary goals. This is known as a(n)

  dual mandate
• The Bank of England, as well as the ECB, put price stability first among all goals. This is known as a(n)

  hierarchical mandate
• In response to an asset-price bubble, macroprudential regulation appears to be the right tool. What is macroprudential regulation?

  Regulatory policy to affect what is happening in credit markets in the aggregate
• The existence of deposit insurance can increase the likelihood that depositors will need deposit protection, as banks with deposit insurance

  are likely to take on greater risks than they otherwise would.
• The possibility that the failure of one bank can hasten the failure of other banks is called the

  contagion effect.
• If the FDIC decides that a bank is too big to fail, it will use the ________ method, effectively ensuring that ________ depositors will suffer losses.

  purchase and assumption; no
• The result of the too-big-to-fail policy is that ________ banks will take on ________ risks, making bank failures more likely.

  large; greater
• Bank regulators can assure depositors that a bank is not taking on too much risk by requiring the bank to

  diversify its loan portfolio

  divest itself of risky assets, such as common stocks.
• When regulators engage in microprudential regulation, they focus on

  the safety and soundness of individual financial institutions.
• The chartering process is especially designed to deal with the ________ problem, and regular bank examinations help to reduce the ________ problem.

  adverse selection; moral hazard
• Banks do not want to hold too much capital because

  they do not bear fully the costs of bank failures.

  higher returns on equity are earned when bank capital is smaller, all else equal.
• In an effort to control the use of derivatives by financial institutions, the Dodd-Frank legislation of 2010 requires

  standardized derivatives products.