Answers to Practice Questions #5

Money and Banking

Fall 2000

a. False. The actions of central banks do affect financial markets since these actions can influence the level of interest rates, the price level and the level of aggregate output in an economy.

2. False. Check your book for dates, but the Federal Reserve was created in 1913.
3. False. The Federal Reserve was created with the idea of diffusing financial power among different regions of the country.
4. False. There had been two national banks earlier in the history of the U.S.
5. True.
6. Uncertain. There are far less likely provided that the central bank is ready to step in and play the role of the lender-of-last-resort.
7. True.
8. False. The Board of Governors sets reserve requirements.
9. False. Only five of the presidents of the Federal Reserve District Banks get to vote (N.Y.’s President is always one of these five).
10. False. Open market operations are directed by the Federal Reserve Open Market Committee.
11. False. The federal funds rate is the rate that banks charge other banks when they borrow funds. The third monetary policy tool is the discount rate, the interest rate that the Fed charges for discount loans to member banks.
12. False. It increases the money supply.
13. True.
14. False. The Fed is independent, but if its policy deviate too far from the goals of the legislative branch, the legislative branch can rewrite the law that created the Fed.
15. Uncertain. This depends on your position. I think the Fed should be independent since it means that its policies will not be influenced by the current political leaders.
16. False. The theory of public interest is the theory that bureaucracies work to serve the public interest, while the theory of bureaucratic behavior is the theory that bureaucracies work to maximize their own welfare.
17. True.
18. Uncertain. Theoretically the Fed should be immune to pressures that would encourage it to contribute to the political business cycle, however there are examples where Fed policy has certainly reflected the political interests of the time.
19. True.
20. False. It will lead to a decrease in interest rates.
21. False. The Fed acts as the bank for the U.S. Treasury.
22. False. Total reserves is the sum of excess reserves plus required reserves.
23. True.
24. False. High powered money is the same thing as the monetary base which is the sum of currency plus reserves.
25. True.
26. False. The Monetary base is equal to the sum of currency plus reserves.
27. True.
28. True.
29. False.
30. True. It depends upon whether the nonblank public elects to hold the Fed’s payments as checkable deposits or as currency.
31. False. The Fed can control the level of the monetary base better than it can reserves because of currency drains.
32. True.
33. True.
34. False.
35. Uncertain. A bank likes holding excess reserves to cover deposit outflows provided that the cost of holding these excess reserves (the foregone interest) is not excessively high.
36. False. The cost to the bank of holding excess reserves is the foregone interest.
37. False. A bank that does not hold a sufficient level of reserves faces the cost imposed by a potential bank run and bank failure as well as the potential costs involved in borrowing the needed funds from other banks or the Fed.
38. True.
39. False. It leads to a small money multiplier.
40. True.
41. False. It means that the Fed is engaging in open market purchases.
42. False. It does not change the money multiplier.
43. Uncertain. If nothing else changes (i.e. other interest rates do not change) then an increase in the discount rate will decrease the level of discount loans and hence will decrease the monetary base and therefore the money supply.
44. Uncertain. If the increase in the interest rate is an interest rate like the Fed funds rate this increase will lead to an increase in the level of discount loans, but it will lead banks to reduce their excess reserves since the cost of holding those excess reserves has risen.
45. False. It is the nonborrowed monetary base.
46. False.
47. True.
48. False. It increased the monetary base but not by a sufficient amount to offset the decrease in the money supply due to the increase in the currency ratio and the increase in the excess reserves ratio.

3. a. i. Decrease in the money supply of $10000.

ii. Decrease in the money supply of $5000.

iii. Decrease in the money supply of $2000.

iv. Decrease in the money supply of $1250.

b. i. Increase in the money supply of $10,000.

ii. Increase in the money supply of $5000.

iii. Increase in the money supply of $2000.

iv. Increase in the money supply of $1250.

c. This is covered well in your book in Chapter 15 pages 389-402.

d. This is covered well in your book in Chapter 15 pages 403-411.

e. The answers to these questions are in the back of your textbook.

f. The answers to these questions are in the back of your textbook.