Chapter 15

Question 1

Cost of excess reserves

Answer 1

opportunity cost, interest rate that could have been earned (irr) minus the interest rate that is paid on reserves (ior)

Question 2

demand curve when iff > ior

Answer 2

downward demand curve

if FFR decreases, the opportunity cost of holding excess reserves falls, and the quantity demanded of reserves increases

Question 3

demand curve when iff <= ior

Answer 3

demand curve becomes flat

banks don’t make overnight loans, they just add on their reserves to earn higher interest

Question 4

two components of non-borrowed reserves

Answer 4

non borrowed resserves supplied by feds OMOs

borrowed reserves borrowed from fed

Question 5

id

Answer 5

cost of borrowing from the Fed at the discount rate

Question 6

Iff

Answer 6

cost of borrowing from other banks at FFR

Question 7

supply curve if Iff<Id

Answer 7

vertical

banks will not borrow from fed and borrowed reserves are 0

Question 8

supply curve if Iff >= Id

Answer 8

banks will borrow more at Id, and re-lend at Iff, horizontal supply curve

Question 9

four tools of monetary policy

Answer 9

OMOs, discount rate, rr, interest on reserves

Question 10

how does an open market sale impact FFR

Answer 10

FFR increases

only if Rs intersects Rd on downward slope

Question 11

how does an open market purchase impact FFR

Answer 11

FFR decreases

only if Rs intersects Rd on downward slope

Question 12

When does OMO have no impact on FFR

Answer 12

when Rs intersects Rd on flat section

Question 13

if intersecion of Rs and Rd occurs on verticals section of Rs, how does discount rate impact FFR

Answer 13

it doesn’t, theres no effect

Question 14

when does a change in the discount rate impact FFR

Answer 14

when the intersection of Rs and Rd occurs on the horizontal section of Rs

Question 15

what happens to FFR when Fed raises rr

Answer 15

FFR rises

Question 16

what happens to FFR when Fed decreases rr

Answer 16

FFR falls

Question 17

when does changing the interest on reserves have an impact on the FFR?

Answer 17

when Rs intersects Rd on flat section

Question 18

conventional monetary policy tools

Answer 18

open market operations, discount lending, reserve requirements

Question 19

dynamic OMOs

Answer 19

strategies used by the Federal Reserve to increase or decrease the amount of money in circulation in the economy

Question 20

defensive OMOs

Answer 20

a type of open market operation (OMO) that aims to change other factors that affect the monetary base and reserves of an economy

Question 21

Repurchase agreement

Answer 21

Fed purchases the securities with an agreement that the seller will buy it back in less than 15 days.

Question 22

Matched sale purchase transaction

Answer 22

Fed sells securities and buyers agree to sell them back in near future.

Question 23

discount window

Answer 23

rate set above the fed fund rate to encourage borrowing from other banks so they closely monitor the credit risks

Question 24

primary credit

Answer 24

given to healthy banks. They can borrow all they want at very short maturity from a primary credit facility at discount rate. (standing lending facility Lombard facility

Question 25

Secondary credit

Answer 25

given to banks with financial difficulty in need of liquidity at a rate higher than discount rate to reflect the less-sound condition of the borrower.

Question 26

seasonal credit

Answer 26

are given to the banks in vacation or agricultural areas.

Question 27

most important motivation for creation of Fed

Answer 27

lender of last resort to prevent financial panics

Question 28

How much does FDIC really cover?

Answer 28

provides insurance to only 1% of total deposits at a bank large deposits over $250,000 aren't covered

Question 29

Fed uses interest on reserves to serve as the ______ for the FFR

Answer 29

floor

Question 30

advantages of OMOs

Answer 30

− complete control over the volume of transactions, − flexible and precise, − easily reversed − can be quickly implemented.

Question 31

advantages of discount rate

Answer 31

− no longer binding for most banks (fed fund rate is normally below discount rate) − liquidity problems and Moral hazard − increases uncertainty for banks.

Question 32

advantages of discount rate

Answer 32

Lender of last resort in extraordinary situations such as the Black Monday (Oct19,1987), Sept 11,2001, and the global financial crisis 2008.

Question 33

advantages of interest on reserves

Answer 33

When banks accumulated a lot of excess reserves, an increase in interest on reserve will rise the fed fund rate without needing a large open market operation

Question 34

why can't fed use conventional monetary policy tools during a financial panic?

Answer 34

1. financial system unable to allocate capital to productive uses 2. negative shock to economy can lead to zero-lower-bound problem both situations - must revert to nonconventional monetary policy

Question 35

Nonconventional monetary policies

Answer 35

liquidity provision large scale asset purchases forward guidance

Question 36

liquidity provision

Answer 36

– Discount Window Expansion (lower discount rate from 1% to 0.5% above the fed fund target) – Term Auction Facility (made loan at a rate determined by auctions) – New Lending Programs ( to IBs )

Question 37

large scale asset purchases

Answer 37

– Government Sponsored Entities Purchase Program – Long-term Treasury securities (QE2) – QE3

Question 38

Forward Guidance

Answer 38

Commitment to future monetary policy actions of keeping the federal funds rate at zero for an extended period, the Fed could lower the market’s expectations of future short-term interest rates, thereby causing the long-term interest rate to fall.

Question 39

skepticism about quantitative easing

Answer 39

expansion of fed assets leads to expansion of MB and MS, stimulates the economy in the short run, and increases inflation in the long run

Question 40

credit easing / benefits

Answer 40

to change the composition of the Fed balance sheet to improve the functioning of particular segments of the credit markets. enables it to allocate capital to productive uses it can lower the int rate on the securities even when the short run rate hits the zero lower bound.