Download 1. In what transaction would the Federal Reserve Bank engage, if it

Auxiliary Problems for Chapter 14
1. In what transaction would the Federal Reserve Bank engage, if it wanted to increase the
money supply through open market operations?
2. List the different methods the Federal Reserve Bank can use to increase the money supply in
the economy?
3. What is the money multiplier when the reserve requirement is:
a) 0.20
b) 0.05
4. Assume that the following data describe the condition of the banking system:
Total Reserves:
Transactions Deposits:
Cash held by the public:
Reserve Requirement:
$300 billion
$900 billion
$125 billion
0.10
a) How large is the money supply (M1)?
b) How large are required reserves?
c) How large are excess reserves?
d) By how much could the banks increase their lending activity?
5. In the problem above, suppose the Fed wanted to stop further lending activity by changing
the reserve requirement. What reserve ratio should the Fed impose?
6. Suppose a $1,000 bond pays $80 per year in interest:
a) What is the interest rate on the bond?
b) If market interest rates fall to 5%, what price will the bond sell for?
7. The combined balance sheet of all the commercial banks in the economy is as follows (in
billions of dollars):
Assets
Liabilities
Reserves
25 Deposits
Government Securities 75
Loans
150
250
a) Assume this bank has no excess reserves, what is the reserve requirement?
b) If the Fed purchases securities of $25 billion, how much in excess reserves do the banks
have immediately after this transaction?
c) By how much would the money supply increase if the banks fully utilized their lending
capacity?
Answers
1. To increase the money supply through open market operations, the Federal Reserve Bank
will buy bonds.
2. 1) lower the reserve ratio; 2) reduce the discount rate; and 3) buy bonds using open market
operations
3. a) 1/0.20 = 5; b) 1/0.05 = 20
4. a) M1 = cash held by the public + Transactions deposits = $900 billion + $125 billion = $1,
025 billion
b) 10% of $900 billion = $900 billion * 0.10 = $90 billion
c) Total reserves – Required Reserves = $300billion - $90 billion = $210 billion.
d) $210 billion*the money multiplier = $210 billion*(1/0.10) = $2,100 billion.
5. Increase the required reserve rate to 33%. We would want required bank reserves to equal
total reserves. Reserve ratio = Total Reserves/Transaction Deposits = 0.33.
6. a) $80/$1,000 * 100 = 8%
b) Present Value of the bond = Future Value/(1 + current market interest rate): $1,080/(1 +
0.05) = $1,029
7. a) $25/$250 * 100 = 10%
b) $25 billion
c) $25*money multiplier = $25*10 = $250
Multiple-Choice 14
1. Which of the following is not a function of one of the 12 Federal Reserve Banks?
a.
b.
c.
d.
Clearing checks.
Conducting monetary policy.
Providing loans to private banks.
Holding bank reserves.
Answer: b
Feedback: The regional Federal Reserve Banks serve as “banker’s banks.” Fed policy is
conducted through the Open Market Committee.
2. The members of the Federal Reserve Board of Governors
a.
b.
c.
d.
Are appointed by the president of the United States.
Are each appointed for a six-year term.
Must have an academic background.
Are appointed for life.
Answer: a
Feedback: The president appoints the Fed chairman and members of the board. Board
members are appointed for 14-year terms, and the chairman is appointed for four years
(and can be reappointed).
3. The Open Market Committee of the Fed is responsible for
a.
b.
c.
d.
Lending money to private banks.
Holding the reserves of private banks.
Making tax and spending decisions.
Monitoring the money supply of the economy.
Answer: d
Feedback: The Open Market Committee of the Fed is the chief policy-making body of the
Federal Reserve system. The FOMC decides whether the economy is growing too slow or
too fast and will adjust the money supply as needed.
4. Which of the following is not a tool of monetary policy?
a.
b.
c.
d.
Changing the reserve requirements.
Changing the discount rate.
Cutting tax rates.
Using open market operations.
Answer: c
Feedback: Tax rates come under the area of fiscal policy, not monetary policy.
5. By raising the reserve requirement, the Fed
a.
b.
c.
d.
Immediately reduces the lending capacity of the banking system.
Immediately increases the lending capacity of the banking system.
Immediately increases banks’ excess reserves.
Allows private banks to borrow more cheaply from the Federal Reserve Bank.
Answer: a
Feedback: Changes in the reserve requirement are infrequent because they have such a
strong effect on banking reserves. When the Fed raises the reserve requirement, bank
lending is sharply reduced.
6. To increase the money supply and reduce interest rates, the Fed will
a.
b.
c.
d.
Raise the reserve requirement.
Sell bonds in the open market.
Buy bonds in the open market.
Raise the discount rate.
Answer: c
Feedback: When the Fed buys bonds, it writes a check to the seller. When the check is
deposited, the bank’s reserves increase, allowing it to provide more loans. This increases
the money supply. Bonds are not money, but bank balances can be quickly converted to
money, so buying bonds increases the money supply.
7. When the Fed purchases bonds at higher price in the open market,
a.
b.
c.
d.
Yields on bonds decrease.
Banks’ required reserve ratio changes.
Banks’ total reserves do not change.
Short-term interest rates rise.
Answer: a
Feedback: If the Fed offers to pay a higher price for bonds, it will lower interest rates.
Higher prices and lower interest rates deter people from investing in bonds because the
yields are less.
8. The monetary policy tool used most frequently by the Fed is
a.
b.
c.
d.
Changing the reserve requirements.
Changing the discount rate.
Changing the price of gold.
Using open market operations.
Answer: d
Feedback: Open market operations involve the buying and selling of government bonds
by the Fed. These transactions are the primary means of implementing monetary policy
because they have the greatest day-to day impact on money supply.
9. The Federal Reserve has lost some control over the money supply due to
a.
b.
c.
d.
The growth of money market accounts at brokerage houses.
Large corporations now lend money.
Globalization of lending activity.
All of the answers are correct.
Answer: d
Feedback: Improvements in communication and data handling have increased the size
and scope of financial markets. This means that the Fed is influenced by financial
decisions made all over the world.
10. The rate at which banks borrow from each other in an overnight market is called the
a.
b.
c.
d.
Discount rate.
Federal funds rate.
Prime rate.
Short-term rate.
Answer: b
Feedback: Banks need to borrow from each other to ensure that they can satisfy their
individual reserve requirements. These short-term loans are called federal funds
transactions.