Chapter 11 Flashcards

Question

What is the currency in a bank's vault?

Answer 1

THe currency in a bank's vault is a RESERVE to meet its depositor's withdrawal's; your bank must replenish currency in its ATM everytime you or other clients take out money.

Answer 2

The **Federal Reserve System (the Fed)** is the central bank of the United States. *A central bank* is a public authority that provides banking services to banks and regulates financial institutions and markets (a central bank does not provide banking services to businesses and individual citizens); the customers the Fed has are like Citibank, Bank of America, and the U.S. government.

Answer 3

**The Fed's main task is to _regulate the interest rate and quantity of money to achieve low and predictable inflation and sustained economic growth._**

Answer 4

- they are partisan to some extent, but they are independent from national politics - they are focused on monetary policy - they work to stabilize the economy - they stimulate growth without creating inflation

Answer 5

1. Control money supply, which means interest rates 2. Lend money to banks and serve as emergency lender of last resort (mom); lender of last resort during financial crisis 3. Set rules for banking, especially the reserve requirement 4. Supervise banks and make sure (by auditing) that they are performing well. WHO in the central bank is making these decisions? -The board of governors, the FOMC

Answer 6

Reserves: Reserves is the currency in the bank's vaults PLUS the balance on its reserve account at the Federal Reserve bank. -Think of reserves as money, actual cash, that banks hold in their vaults into ATM machines and what is in the bank's checking account at the Fed.

Answer 7

1. Banks need to think about their liquidity, people will rush to take money out of the bank. 2. By law, banks must hold a certain percentage of demand deposits, of checking deposits, AS RESERVES.

Answer 8

**Reserve ratios:** Reserve ratios are the legal percentage of demand deposits that must be held as reserves r= (today) about 10% mandated by central bank r = R % D R: banks required reserve to hold D=demand deposits

Answer 9

* The Board of Governors sets (within limits) the required reserve ratios. * Banks hold reserves. (These reserves are currency in the institutions' vaults and ATMS, and deposits held with other banks or with the Fed). * Banks and thrifts are required to hold a minimum percentage of deposits as reserves, a required reserve ratio. * ^The Fed determines the RRR for each type of deposit (minimum percentage of deposits as reserves)

Answer 10

The interest rate can be lowered by increasing the money supply (cash/demand deposits) Reserves →M ^ → i (decrease) → C^, I^ Central bank can influence **C, I,** (G, Nx)

Answer 11

Act causes banks to be more prudent about the kinds of loans they make.

Answer 12

- The nation is divided into 12 Federal Reserve districts. - Each Federal Reserve district has its own Federal Reserve bank. - The HQ is in D.C. (thus, the Board of Governors is in D.C.)

Answer 13

There are 4 key elements in the structure of the Federal Reserve: 1. The Chairman of the Board of Governors 2. The Board of Governors 3. The Regional Federal Reserve Banks 4. The Federal Open Market Committee\* (\*system's principal monetary policymaking body)

Answer 14

1. The chairman of the Board of Governors is the Fed's chief executive, public face, and the center of power and responsibility. 2. When things go right, the chairman gets the credit, when things go wrong, he or she gets the blame. **Right now the Chairman of the Board of Governors is Janet Yellen.**

Answer 15

- Seven members, appointed by the President of the United States and confirmed by the Senate - Each member serves a 14-year term (the terms are staggered so that one seat on the board becomes vacant every 2 years) - The President appoints one of the boardmembers as Chairman for a term of 4 years, which is renewable. - The President appoints, but cannot remove--we want our board to be mostly isolated from politics.

Answer 16

- They are all on the FOMC - They set (within limits) the reserve requirements. - The invoke the emergency lending powers (lender of last resort). - They review and determine the discount rate. - The appoint 3 directors to represent the public (for Federal Reserve district banks)

Answer 17

- There are 12 Federal Reserve Banks, one for each of the 12 Federal Reserve districts. - Each Federal Reserve bank has 9 directors (3 of whom are appointed by the Board of Governors and 6 of whom are elected by the commercial banks [aka member banks, the public] in the Federal Reserve distrcit. - The Federal Reserve Bank of New York implements some of the Fed's most important policy decisions. - THEY HELP RECOMMEND THE DISCOUNT RATE. - 5 Reserve presidents are on the FOMC.

Answer 18

**The Federal Open Market Committee (FOMC) is the Fed's main policy-making committee.** -The FOMC consists of _12 members_: The chariman and the 6 other members of the Board of Governors The president of the Federal Reserve Bank of New York -4 presidents of the other regional Federal Reserve banks (on a yearly rotating basis).

Answer 19

- They meet every 6 weeks. - They _set_ **the federal funds rate target, open market operations, and liquidity/credit facilities.** - They _control_ the discount rate.

Answer 20

- Influence over interest rates is LLR - How it intervenes as LLR is to decide whether ot lend money to banks. - They can change the interest rate, the discount rate.

Answer 21

The Fed uses 4 main policy tools: 1. Required reserve ratios 2. Discount rate 3. Open market operations 4. Extraordinary crisis measures

Answer 22

The Fed's most important tasks are to influence the interest rate and regulate the amount of money circulating in the U.S. The Fed does this by adjusting the reserves of the banking system and standing ready to make loans to banks (in this way, the Fed is able to prevent bank failures).

Answer 23

- The discount rate is the interest rate at which the Fed stands ready to lend reserves to commercial banks. - A change in the discount rate begins with a proposal to the FOMC by at least one of the 12 Federal Reserve banks. - If the FOMC agrees that a change is required, it proposes the change to the Board of Governors for its approval. - You can lower the interest rate through OMO. - OMO-buying and selling of U.S. securities and bonds by the Central Bank (Fed decides how much and when).

Answer 24

-The Federal Open Market Committee

Answer 25

- An **open market operation is the purchase or sale of government securities--U.S. Treasury bills and bonds--by the New York Fed in the open market.** - When the New York Fed conducts an open market operation, it does NOT transact with the federal government. - It does make a transaction with a bank or some other business, however--just not the federal government. - The NY Fed conducts the Fed's OMO.

Answer 26

Following the collapse of Lehman Brothers, the Fed (working closely with the U.S. treasury) created 3 tools: 1. Quantitative easing 2. Credit easing 3. Operation twist

Answer 27

**Quantitative Easing (QE)- When the Fed creates bank reserves by conducting a large-scale open market purchase at a low or possibly zero federal funds rate, the action is called *quantitative easing.*** * -*This action differs from a normal open market purchase in its scale and purpose, and it might require the Fed to buy any number of private securities rather than government securities. - QE is designed to stimulate growth by giving banks a greater capacity to make loans. - This occured every year from 2008-2013, except 2009. - Fannie Mae, Freddie Mac (mortgage-based securities)

Answer 28

When the Fed buys private securities or makes loans to financial institutions to stimulate their lending, the action is called credit easing. I.e. the bailout of the big banks via Maiden Lane et al.

Answer 29

- An **operation twist is when the Fed buys long-term government securities and sells short-term government securities.\*** - This happened in September 2011, and then again in 2012. \*The idea is to lower long-term interest rates and stimulate borrowing and investment.

Answer 30

The **monetary base is the sum of coins, Federal Reserve notes, and banks' reserves at the Fed.** - The monetary base is so called because it acts like a base that supports the nation's money. - The larger the monetary base, the greater the quantity of money that it can support.

Answer 31

To increase: 1. Increase the required reserve rati, the Fed can force banks to hhold a larger quantity of monetary base 2. Raise the discount rate, Fed can make it more costly for banks to borrow reserves--borrow the monetary base 3. SELL securities in the open market and decrease the monetary base which increases the interest rate

Answer 32

To decrease interest rate: 1. Decrease RRR, Fed can permit banks to hold a smaller quantity of monetary base 2. Lower discount rate, Fed can make it less costly for banks to borrow monetary base 3. Buy securities in open market, Fed increase monetary base

Answer 33

By making loans!

Answer 34

The quantity of deposits that banks create are limited by 3 factors: 1. the monetary base 2. desired reserves 3 desired currency holdings

Answer 35

The monetary base is the sum of Federal Reserve notes, coins, and banks' deposits at the Fed.

Answer 36

The size of the monetary base limits the total quantity of money that the banking system can create because 1. banks have desired reserves\* 2. households and firms having desired currency holdings\* \*both of these desired holdings of monetary base depend on the quantity of money

Answer 37

**Excess reserves** equal the bank's actual reserves minus its desired reserves. - When the banking system as a whole has excess reserves, banks can create money by making new loans. - When a bank is short of reserves, it must destroy money by decreasing quantity of loans.

Answer 38

-We hold money in the form of currency and bank deposits and some fraction of their money as currency. The proportion of money held as currency isn't constant, but at any given time, people have a definite view as to how much they want to hold in each form of money (currency vs bank deposits). -Because households and firms want to hold some proportion of their money in the form of currency, when the total quantity of bank deposits increases, so does the quantity of currency they want to hold.

Answer 39

-Because desired currency holding increases when deposits increase, currency leaves the banks when they make loans and increase deposits. THIS LEAKAGE OF CURRENCY FROM THE BANKING SYSTEM IS CALLED THE **CURRENCY DRAIN**. The ratio of currency to deposits is called the _currency drain ratio_. [The greater the currency drain ratio, the smaller is the quantity of deposits and money that the banking system can create from a given monetary base.] -As currency drains from the banks, they are left with a smaller level of reserves (and smaller excess reserves), so they make fewer loans.

Answer 40

-The Fed's most significant policy tool is AN OPEN MARKET OPERATION. ## Footnote **An open market operation is the purchase or sale of government securities by the Fed in the open market.**

Answer 41

- When the Fed buys securities in an open market operation, it pays for them with newly created bank reserves and money. - With more reserves in the banking system, the supply of interbank loans increase, the demand for interbank loans decrease, and then the federal funds rate falls. **The federal funds rate** is the interest rate on loans in the interbank market.

Answer 42

- An open market purchase that increases bank reserves also increases the monetary base by the amount of the open market purchase. - The increase in the monetary base equals the amount of the open market purchase. - The quantity of bank reserves increases and gives banks excess reserves that they can start to lend (regardless of whether the Fed buys securities from the banks or from the public).

Answer 43

**The money multiplier is the number by which a change in the monetary base is multiplied to find the resulting change in the quantity of money.** - It is also the ratio of the change in the quantity of money to the change in the monetary base. - The magnitude of the money multiplier depends on the desired reserve ratio (R) and the currency drain ratio (the ratio of currency to deposits C).

Answer 44

MB, monetary base= R (desired reserves) + C (currency)

Answer 45

M= Deposits + Currency = (D+ C)

Chapter 11 Flashcards

(69 cards)