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Question: The Federal Reserve wants to increase the


The Federal Reserve wants to increase the supply of reserves, so it purchases 1 million dollars’ worth of bonds from primary dealers. Show the effect of this open market operation using T-accounts.


> Why do loan sharks worry less about moral hazard in connection with their borrowers than some other lenders do?

> Why does the U.S. government use the money markets?

> If you want to earn an annualized discount rate of 3.5%, what is the most you can pay for a 91-day Treasury bill that pays $5,000 at maturity?

> If the Treasury also received $750 million in noncompetitive bids, who will receive T-bills, in what quantity, and at what price? (Refer to the table in problem 11.) Table from Problem 11: Bid Amount Bidder ($ million) Price ($) 1 500 0.9940 750 0.

> In a Treasury auction of $2.1 billion par value 91-day T-bills, the following bids were submitted: If only these competitive bids are received, who will receive T-bills, in what quantity, and at what price? Bid Amount Bidder ($ million) Price ($) 1

> How much would you pay for a Treasury bill that matures in 182 days and pays $10,000 if you require a 1.8% discount rate?

> The price of 182-day commercial paper is $7,840. If the annualized investment rate is 4.093%, what will the paper pay at maturity?

> What is the annualized discount and investment rate % on a Treasury bill that you purchase for $9,900 that will mature in 91 days for $10,000?

> What are the annualized discount rate % and your annualized investment rate % on a Treasury bill that you purchase for $9,940 that will mature in 91 days for $10,000?

> What would be your annualized discount rate % and your annualized investment rate % on the purchase of a 182-day Treasury bill for $4,925 that pays $5,000 at maturity?

> The annualized yield is 3% for 91-day commercial paper and 3.5% for 182-day commercial paper. What is the expected 91-day commercial paper rate 91 days from now?

> If you suspect that a company will go bankrupt next year, which would you rather hold, bonds issued by the company or equities issued by the company? Why?

> The annualized discount rate on a particular money market instrument is 3.75%. The face value is $200,000, and it matures in 51 days. What is its price? What would be the price if it had 71 days to maturity?

> How much would you pay for a Treasury bill that matures in one year and pays $10,000 if you require a 3% discount rate?

> The price of $8,000 face value commercial paper is $7,930. If the annualized discount rate is 4%, when will the paper mature? If the annualized investment rate % is 4%, when will the paper mature?

> The benefits of using Fed discount operations to prevent bank panics are straightforward. What are the costs?

> “Discounting is no longer needed because the presence of the FDIC eliminates the possibility of bank panics.” Is this statement true, false, or uncertain? Explain your answer.

> “Unemployment is a bad thing, and the government should make every effort to eliminate it.” Do you agree or disagree? Explain your answer.

> “A central bank with a dual mandate will achieve lower unemployment in the long run than a central bank with a hierarchical mandate in which price stability takes precedence.” Is this statement true, false, or uncertain?

> Why might inflation targeting increase support for the independence of the central bank to conduct monetary policy?

> What methods have inflation-targeting central banks used to increase communication with the public and increase the transparency of monetary policy making?

> What are the benefits of using a nominal anchor for the conduct of monetary policy?

> The U.S. economy borrowed heavily from the British in the nineteenth century to build a railroad system. What was the principal debt instrument used? Why did this make both countries better off?

> When interest rates rise, how might businesses and consumers change their economic behavior?

> Compare the monetary base to M2 on the grounds of controllability and measurability. Which do you prefer as an intermediate target? Why?

> “Interest rates can be measured more accurately and more quickly than the money supply. Hence an interest rate is preferred over the money supply as an intermediate target.” Do you agree or disagree? Explain your answer.

> If the Fed has an interest-rate target, why will an increase in the demand for reserves lead to a rise in the money supply?

> What procedures can the Fed use to control the three-month Treasury bill rate? Why does control of this interest rate imply that the Fed will lose control of the money supply?

> Classify each of the following as either an operating target or an intermediate target, and explain why. a. The three-month Treasury bill rate b. The monetary base c. M2

> “If the demand for reserves did not fluctuate, the Fed could pursue both a nonborrowed reserves target and an interest-rate target at the same time.” Is this statement true, false, or uncertain? Explain your answer.

> Which goals of the Fed frequently conflict?

> According to the Greenspan doctrine, under what conditions might a central bank respond to a perceived stock market bubble?

> Why would it be better to lean against credit-driven bubbles and clean after other types of asset bubbles crash?

> Why aren’t most central banks more proactive at trying to use monetary policy to eliminate asset-price bubbles?

> If I can buy a car today for $5,000 and it is worth $10,000 in extra income next year to me because it enables me to get a job as a traveling anvil seller, should I take out a loan from Larry the loan shark at a 90% interest rate if no one else will give

> If higher inflation is bad, then why might it be more advantageous to have a higher inflation target than a lower target closer to zero?

> “The zero-lower-bound on short-term interest rates is not a problem, since the central bank can just use quantitative easing to lower intermediate and longerterm interest rates instead.” Is this statement true, false, or uncertain? Explain.

> “Because inflation targeting focuses on achieving the inflation target, it will lead to excessive output fluctuations.” Is this statement true, false, or uncertain? Explain your answer.

> What incentives arise for a central bank to fall into the time-inconsistency trap of pursuing overly expansionary monetary policy?

> What are the main advantage and the main disadvantage of an unconditional policy commitment?

> Why is the composition of the Fed’s balance sheet a potentially important aspect of monetary policy during a crisis?

> What are the advantages and disadvantages of quantitative easing as an alternative to conventional monetary policy when short-term interest rates are at the zero-lower-bound?

> Why was the Term Auction Facility more widely used by financial institutions than the discount window during the global financial crisis?

> With the onset of the global financial crisis, assets on the Federal Reserve’s balance sheet increased dramatically, from approximately $800 billion in 2007 to over $3 trillion in 2013. Many of the assets held are longer-term securities acquired through

> Consider a bank policy to maintain 12% of deposits as reserves. The bank currently has $10 million in deposits and holds $400,000 in excess reserves. What is the required reserve on a new deposit of $50,000?

> Why might you be willing to make a loan to your neighbor by putting funds in a savings account earning a 5% interest rate at the bank and having the bank lend her the funds at a 10% interest rate rather than lend her the funds yourself?

> A bank currently holds $150,000 in excess reserves. If the current reserve requirement is 12.5%, how much could the money supply change? How could this happen?

> The short-term nominal interest rate is 5%, with an expected inflation of 2%. Economists forecast that next year’s nominal rate will increase by 100 basis points, but inflation will fall to 1.5%. What is the expected change in real interest rates?

> Use T-accounts to show the effect of the Federal Reserve being paid back a $500,000 discount loan from a bank.

> Estimates of unemployment for the upcoming year have been developed as follows: What is the expected unemployment rate? The standard deviation? Unemployment Rate (%) Economy Probability Bust 0.15 20 Average 0.50 10 Good 0.20 5 Вoom 0.15 1

> The trading desk at the Federal Reserve sold $100,000,000 in T-bills to the public. If the current reserve requirement is 8.0%, how much could the money supply change?

> If the required reserve ratio is 10%, how much of a new $10,000 deposit can a bank lend? What is the potential impact on the money supply?

> Which entities in the Federal Reserve System control the discount rate? Reserve requirements? Open market operations?

> In what ways can the regional Federal Reserve banks influence the conduct of monetary policy?

> What political realities might explain why the Federal Reserve Act of 1913 placed two Federal Reserve banks in Missouri?

> If there were no asymmetry in the information that a borrower and a lender had, could there still be a moral hazard problem?

> Why was the Federal Reserve System set up with 12 regional Federal Reserve banks rather than one central bank, as in other countries?

> “The independence of the Fed leaves it completely unaccountable for its actions.” Is this statement true, false, or uncertain? Explain your answer.

> Why might eliminating the Fed’s independence lead to a more pronounced political business cycle?

> “The theory of bureaucratic behavior indicates that the Fed never operates in the public interest.” Is this statement true, false, or uncertain? Explain your answer.

> What is the primary tool that Congress uses to exercise some control over the Fed?

> The Fed is the most independent of all U.S. government agencies. What is the main difference between it and other government agencies that explains the Fed’s greater independence?

> Do you think that the 14-year nonrenewable terms for governors effectively insulate the Board of Governors from political pressure?

> “The Federal Reserve System resembles the U.S. Constitution in that it was designed with many checks and balances.” Discuss.

> The Fed promotes secrecy by not releasing the minutes of the FOMC meetings to Congress or the public immediately. Discuss the pros and cons of this policy.

> “The independence of the Fed has meant that it takes the long view and not the short view.” Is this statement true, false, or uncertain? Explain your answer.

> How can the adverse selection problem explain why you are more likely to make a loan to a family member than to a stranger?

> In the 1960s and 1970s, the Federal Reserve System lost member banks at a rapid rate. How can the theory of bureaucratic behavior explain the Fed’s campaign for legislation to require all commercial banks to become members? Was the Fed successful in this

> Compare the structure and independence of the Federal Reserve System and the European System of Central Banks.

> Why do bank panics worsen asymmetric information problems in credit markets?

> How can a sovereign debt crisis make an economic contraction more likely?

> Why are more resources not devoted to adequate, prudential supervision of the financial system to limit excessive risk taking, when it is clear that this supervision is needed to prevent financial crises?

> Why is the originate-to-distribute business model subject to the principal–agent problem?

> What is a credit spread? Why do credit spreads rise during financial crises?

> How does a general increase in uncertainty as a result of a failure of a major financial institution lead to an increase in adverse selection and moral hazard problems?

> How does a deterioration in balance sheets of financial institutions cause a decline in economic activity?

> How can a decline in real estate prices cause deleveraging and a decline in lending?

> Why do managers of financial institutions care so much about the activities of the Federal Reserve System?

> How does an unanticipated decline in the price level cause a drop in lending?

> How can a bursting of an asset-price bubble in the stock market help trigger a financial crisis?

> How does the concept of asymmetric information help to define a financial crisis?

> How did the global financial crisis promote a sovereign debt crisis in Europe?

> Why would haircuts on collateral increase sharply during a financial crisis? How would this lead to fire sales on assets?

> What is the shadow banking system, and why was it an important part of the 2007–2009 financial crisis?

> How did a decline in housing prices help trigger the subprime financial crisis starting in 2007?

> True, false, or uncertain: Financial engineering always leads to a more efficient financial system.

> What technological innovations led to the development of the subprime mortgage market?

> Describe two similarities and two differences between the U.S. experiences during the Great Depression and those during the global financial crisis of 2007–2009.

> What types of risks do financial institutions face?

> What role do weak financial regulation and supervision play in causing financial crises?

> How can financial liberalizations lead to financial crises?

> What causes bank panics?

> Why can the provision of several types of financial services by one firm lead to a lower cost of information production?

> “The more collateral there is backing a loan, the less the lender has to worry about adverse selection.” Is this statement true, false, or uncertain? Explain your answer.

> How does spinning lead to a less efficient financial system?

> How can conflicts of interest make financial service firms less efficient?

> How does the provision of several types of financial services by one firm lead to conflicts of interest?

> Which firms are most likely to use bank financing than to issue bonds or stocks to finance their activities? Why?

> Do you think the lemons problem would be more severe for stocks traded on the New York Stock Exchange or those traded over the counter? Explain.

> Why are financial markets important to the health of the economy?

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