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CHAPTER NINE Global Money and Banking — Where Central Banks Fit into the World Economy True/False 1. When the Bank of England was made independent of the government in 1997 estimates of the expected level of inflation in Britain almost immediately fell. Ans: True Dif: E 2. The Bank of England was the first central bank. Ans: False Dif: E 3. The most recently established major central bank is the European Central Bank. Ans: True Dif: E 4. Today there are only three central banks that can engage in policymaking activities that would affect the global economy. Ans: True Dif: M 5. The central banks of the individual European countries that joined the European Monetary Union were dissolved when the European Central Bank took over. Ans: False Dif: E 6. The U.S. Federal Reserve serves as a bank for the U.S. Treasury. Ans: True Dif: E 7. Much of the debt issued by the U.S. Treasury is sold at auctions conducted by the Federal Reserve Bank. Ans: True Dif: M 8. Bank runs can occur when there is no deposit insurance or lender of last resort because banks typically keep only a fraction of the deposits at the bank. Ans: True Dif: M 262 Global Money and Banking — Where Central Banks Fit into the World Economy 9. A systemic banking failure is one where large numbers of banks fail. Ans: True Dif: E 10. The interest rate that banks charge each other on loans of excess reserves is called the discount rate. Ans: False Dif: M 11. The interest rate that the Federal Reserve charges on loans to private banks is called the fed funds rate. Ans: False Dif: M 12. One of the purposes of SDRs has been to provide an international currency to settle transactions between governments. Ans: True Dif: M 13. Currency notes are the major asset at most central banks. Ans: False Dif: M 14. The two basic components of M1 are currency and transactions deposits. Ans: True Dif: E 15. Eurodollar deposits are defined as deposits of dollars held in European banks. Ans: False Dif: M 16. The monetary base comprises the major liabilities of most large central banks. Ans: True Dif: M 17. The Lombard rate is the below market interest rate that the ECB charges to private banks to borrow from the ECB. Ans: False Dif: M 18. The money multiplier can be increased by reducing the required reserve ratio on transaction accounts. Ans: True Dif: M 19. If the central bank purchases government securities normally we can expect interest rates to fall. Ans: True Dif: M 263 264 Chapter 9 — Test Bank 20. If the Federal Reserve wishes to temporarily increase the money supply they could enter into a reverse repurchase agreement. Ans: True Dif: D 21. Generally speaking, the money supply and interest rates vary inversely. Ans: True Dif: E 22. National income is equal to national output which is also equal to national income. Ans: True Dif: E 23. Measuring prices at their final value, nominal GDP is the sum of (price * quantity) for all goods and services produced within a country’s borders during a given time period. Ans: True Dif: M 24. If prices have always been steadily rising and 1996 is the base year for calculating the GDP deflator, then for all years priors to 1996 real GDP will be greater than nominal GDP and for all years after 1996 real GDP will be less than nominal GDP. Ans: True Dif: D 25. Ceteris paribus, an increase in the money supply will result in a depreciation in the currency value. Ans: True Dif: M 26. One of the main purposes of central banks ‘leaning with the wind’ policies is to reduce currency volatility. Ans: False Dif: M 27. The U.S. Treasury, instead of the Federal Reserve, has the primary responsibility for initiating foreign exchange interventions. Ans: True Dif: M 28. Dominguez and Frankel found that announcement effects of government interventions had larger effects on currency values than the magnitude of the interventions themselves, thus providing strong evidence for the portfolio balance effect. Ans: False Dif: M Global Money and Banking — Where Central Banks Fit into the World Economy Multiple Choice 1. The first central bank was established in what century? A) sixteenth century B) seventeenth century C) eighteenth century D) nineteenth century E) twentieth century Ans: B Dif: M 2. The first central bank was established in what country? A) America B) England C) France D) Switzerland E) Sweden Ans: E Dif: M 3. Central banks often serve as fiscal agents for the national government. This implies that they A) issue, service and redeem government debt. B) monitor the nation’s banking systems. C) manage foreign exchange values. D) implement monetary policy. E) none of the above Ans: A Dif: M 4. Central banks in less developed countries often have expanded fiscal agent duties including I. finding buyers for government debt. II. directly buying government debt. III. requiring the government to reduce its debt level. A) I only B) II only C) I and II only D) I and III only E) I, II and III Ans: C Dif: M 265 266 Chapter 9 — Test Bank 5. In broad terms the role of a central bank includes all but which one of the following? A) providing banking services to the government B) acting as a fiscal agent for the government C) monitoring banking systems to ensure stability D) directing and implementing monetary policy E) directing and implementing fiscal policy Ans: E Dif: E 6. When the majority of a bank’s depositors seek to withdraw their deposits at the same time this is called a A) systemic failure. B) bank run. C) lender of last resort. D) temporary reserve deficit. E) contagion. Ans: B Dif: E 7. When the central bank meets temporary shortfalls in liquidity at a bank it is fulfilling its __________ function. A) monetary policy B) fiscal agent C) lender of last resort D) monitoring E) systemic Ans: C Dif: E 8. The major category of assets of the Federal Reserve and the Bank of Japan are A) national currency. B) foreign currency reserves. C) securities issued by their national government. D) gold and SDR certificates. E) government deposits. Ans: C Dif: E 9. Most central banks devote the bulk of their resources to their __________ function. A) monetary policy B) fiscal agent C) lender of last resort D) bank monitoring E) foreign exchange monitoring Ans: B Dif: M Global Money and Banking — Where Central Banks Fit into the World Economy 10. Which of the following two central banks engage in proportionately the most discount window lending? I. the U.S. Federal Reserve II. the Bank of Japan III. the ECB A) I and II B) I and III C) II and III D) All three engage in approximately equal amounts of this type lending. Ans: C Dif: M 11. The interest rate that the Federal Reserve charges on loans to private banks is called the A) Lombard rate. B) fed funds rate. C) prime rate. D) LIBOR rate. E) none of the above Ans: E Dif: E 12. Total domestic securities plus loans held as assets by a central bank are called A) M1. B) M2. C) M3. D) the monetary base. E) none of the above Ans: E Dif: M 13. Excess reserves are A) reserves that banks must hold at the central bank to back loans. B) reserves that banks must hold at the central bank to back deposits. C) vault cash and reserves held at the central bank in excess of required reserves. D) loaned between banks for short time periods at the discount rate. E) none of the above Ans: C Dif: E 14. The fundamental functions of money include all but which one of the following? A) medium of exchange B) store of value C) unit of account D) maintaining constant purchasing power E) standard of deferred payment Ans: D Dif: M 267 268 Chapter 9 — Test Bank 15. The standard of deferred payment function is most similar to which other function of money? A) medium of exchange B) store of value C) unit of account D) maintaining constant purchasing power Ans: B Dif: M 16. If the price of a new tire for your car is twenty loaves of bread this would violate which of the functions of money? A) medium of exchange B) store of value C) unit of account D) maintaining constant purchasing power E) standard of deferred payment Ans: C Dif: M 17. Central bank holdings of domestic securities, loans and foreign exchange reserves are called A) the monetary aggregate B) the monetary base C) M1 D) M2 E) domestic credit Ans: B Dif: E 18. The narrowest measure of money is A) M1. B) M2. C) M3. D) the monetary base. E) checkable deposits. Ans: D Dif: E 19. The monetary aggregate that is designed to measure immediately spendable funds is called A) M1. B) M2. C) M3. D) the monetary base. E) checkable deposits. Ans: A Dif: M Global Money and Banking — Where Central Banks Fit into the World Economy 20. M2 includes which of the following components? I. II. III. IV. M1 savings accounts time deposits greater than $100,000 overnight repurchase agreements A) I only B) I and II only C) I, II and III only D) II, III and IV only E) I, II, III and IV Ans: B Dif: M 21. Suppose that the Federal Reserve wishes to stimulate the economy. Which of the following could be used to help accomplish this goal? I. purchase government securities II. increase the discount rate III. lower reserve requirements A) I only B) II only C) I and II only D) I and III only E) I, II and III Ans: D Dif: M 22. Which one of the following monetary policy tools is used less frequently by central banks of less developed economies? A) open market operations B) changes in the discount rate C) credit controls D) interest rate controls E) reserve requirements Ans: A Dif: E 269 270 Chapter 9 — Test Bank 23. Which of the following actions would cause the money multiplier to be overstated following a central bank’s actions to increase bank reserves? I. A loan customer withdraws the loan proceeds from the bank and holds it in the form of cash. II. A loan customer uses the loan proceeds to pay off his credit card. III. A bank increases it holdings of excess reserves. A) I only B) II only C) I and II only D) I and III only E) I, II and III Ans: D Dif: D 24. The Federal Reserve increases bank reserves by $8 million. If reserve requirements are 10%, by how much should deposits increase? A) $8 million B) $0.8 million C) $80 million D) $8.8 million E) none of the above Ans: C Dif: E 25. If deposits decrease by $50 million as a result of a Federal Reserve action to decrease bank reserves and if reserve requirements are 12%, by how much did the Fed change bank reserves? A) $6 million B) $416.7 million C) $44 million D) $9 million E) none of the above Ans: A Dif: M 26. The final value of all goods and services produced within a country’s borders during a given period is called A) GNP. B) GDP. C) GDP deflator. D) exports. E) central bank reserves. Ans: B Dif: B Global Money and Banking — Where Central Banks Fit into the World Economy 27. You notice that nominal GDP rose by 3% in a country last year. Which one of the following must be true? A) The real production of goods and services in that country rose by 3%. B) The real production of goods and services in that country rose by more than 3%. C) The real production of goods and services in that country rose by less than 3%. D) The real production of goods and services in that country could have risen by more or less than 3%. E) The GDP deflator must be less than one. Ans: D Dif: E 28. Total nominal income for a country is equal to $200 billion when the GDP deflator is equal to 1.25. Real income must be A) $160 billion. B) $200 billion. C) $250 billion. D) $185 billion. E) $175 billion. Ans: A Dif: E 29. The aggregate demand curve is downward sloping because an increase in the price level I. increases the real value of the money in circulation. II. reduces the real value of liquid asset holdings, inducing people to borrow more. III. reduces foreign demand for domestic goods and services. A) I only B) II only C) II and III only D) I and III only E) I, II and III Ans: C Dif: D 30. If the long run aggregate supply curve is vertical then in the long run an increase in the money supply causes A) real growth and some inflation. B) inflation only. C) inflation and a drop in domestic currency value, but no sustained real growth in output. D) some inflation and some increase in currency value. E) a change in the money multiplier. Ans: C Dif: D 271 272 Chapter 9 — Test Bank 31. A central bank intervenes by buying foreign currency reserves when the domestic currency’s value has recently been declining. This is an example of A) leaning against the wind. B) leaning with the wind. C) a crawling peg. D) a G5 intervention. E) an aggregate supply change. Ans: B Dif: M 32. Suppose that over time a country’s productivity grows significantly. This is an example of a/an A) increase in aggregate demand. B) decrease in aggregate demand. C) increase in aggregate supply. D) decrease in aggregate supply. E) none of the above Ans: C Dif: D 33. The Federal Reserve increases the U.S. money supply. This is an example of a/an A) increase in aggregate demand. B) decrease in aggregate demand. C) increase in aggregate supply. D) decrease in aggregate supply. E) none of the above Ans: A Dif: M 34. Suppose that the Bank of Japan sells yen on the open market. To sterilize this transaction with open market operations the Bank of Japan should A) buy Japanese government bonds. B) sell Japanese government bonds. C) raise reserve requirements. D) lower the discount rate. E) reduce credit controls on banks. Ans: B Dif: D Global Money and Banking — Where Central Banks Fit into the World Economy 35. If the Federal Reserve buys yen bonds and sells dollar bonds, the resulting portfolio balance effect should cause which of the following? I. an increase in the price of dollar denominated bonds. II. a decrease in the rate of return of dollar denominated bonds. III. an increase in the value of the yen. A) I only B) I and II only C) II and III only D) I and III only E) I, II and III Ans: E Dif: D 36. If the Federal Reserve buys dollar denominated bonds and sells euro denominated bonds in the foreign exchange market, which of the following is true? I. The dollar should fall in value. II. The announcement effect may be greater than the portfolio balance effect. II. U.S interest rates should rise. A) I only B) II only C) II and III only D) I and III only E) I, II and III Ans: B Dif: D 37. Which of the following statements about non-sterilized interventions by the major central banks is true? I. They probably have little permanent effect on currency values. II. They may contribute to foreign exchange volatility. III. They can lead to large taxpayer losses due to the greater currency risks undertaken by the central banks. A) I only B) II only C) II and III only D) I and III only E) I, II and III Ans: E Dif: E 273 274 Chapter 9 — Test Bank 38. The purpose of sterilized interventions in the foreign exchange markets is to A) change the currency value without affecting the domestic money supply. B) change the domestic money supply affecting the currency’s value. C) change both the currency value and the domestic money supply. D) stability the currency’s value and the domestic money supply. E) stabilize the money supply while allowing the currency value to float. Ans: A Dif: M