Download answers to "do you understand" text questions

Chapter 3: ANSWERS TO "DO YOU UNDERSTAND" TEXT QUESTIONS
DO YOU UNDERSTAND?
1. What is likely to happen to the monetary base if (a) the Treasury department sends out Social
Security checks payable from its account at the Fed, (b) the Fed buys more government securities, (c)
banks in general borrow less from the Fed’s discount window and repay their past borrowings?
Solution: (a) the MB will increase as the Treasury checks clear the Fed providing increased bank
reserves; (b) the MB will increase as the Fed purchases securities, increasing the bank reserve deposit
account in the Fed; (c) the repayment of Fed borrowings will reduce the bank reserve deposit
component of the MB.
2. What is likely to happen to the Fed Funds rate under the scenarios in the previous question?
Solution: Any action which increases bank reserves increases the supply of loanable funds to the fed
funds market and will decrease the fed funds rate. Any transaction which decreases bank reserves will
increase the fed funds rate.
3. What is likely to happen to the Fed Funds rate if the Fed increases the reserve requirement?
Explain.
Solution: An increase in reserve requirements, given the level of deposits, will immediately create a
reserve deficiency, increasing the fed funds rate.
4. Why do the financial markets pay so much attention to the Fed Funds rate given that the Fed can’t
really control that interest rate in the long run?
Solution: In the short run open market operations can influence the fed funds rate, money market
rates, and indexed rates in lending agreements. Anticipating open market operations efforts might also
be used as a speculative venture.
DO YOU UNDERSTAND?
1. Describe the likely consequences for GDP growth when the FOMC directs the trading desk at the
New York Fed to sell Treasury securities.
Solution: Selling securities reduces bank reserves, money market liquidity, the bank's availability of
funds, and might increase interest rates, serving the slow the economy.
2. What defensive actions do you suppose the Fed takes during periods of time when cash holdings
by the public increases? In other words, how does the Fed offset these cash drains?
Solution: The Fed seeks to control the total monetary base, not the individual components, so when
the public cash holdings increase, decreasing bank reserves, the Fed would purchase Treasury
securities, (open market operations) increasing and offsetting the public cash hording.
3. As a college student that will be entering the workforce soon, if not already, which of the objectives
of monetary policy would you like the Fed to focus on in the coming years?
Solution: As a student hopeful or prayerful of graduation, full employment is likely to be your favorite
economic policy objective.