Central Banks and the Federal Reserve System
Multiple Deposit Creation and the Money Supply Process
1. Identifications: Identify and briefly explain the significance of the following terms.
Federal Reserve System
Federal Open Market Committee
Board of Governors
Chairman of the Fed
Reserve Requirements
Open Market Operations
Discount Rate
Public Interest View
Theory of Bureaucratic Behavior
Political Business Cycle
Green Book of the Federal Reserve
Blue Book of the Federal Reserve
Beige Book of the Federal Reserve
Discount Loan
Required Reserves
Excess Reserves
Monetary Base
High Powered Money
Float
Simple Money Multiplier
Currency Drains
Multiple Deposit Creation
Fractional Reserve Banking System
Required Reserve Ratio
Open Market Purchase
Open Market Sale
Nonborrowed Monetary Base
Excess Reserves Ratio
Currency Ratio
Expected Deposit Outflows
2. Short Responses: For the following statements, state whether you agree, disagree, or cannot decide. Explain your position in a paragraph.
a. The actions of Central Banks do not impact financial markets.
b. The Federal Reserve Bank is one of the oldest central banks in the world.
c. The Federal Reserve System was created with the idea of centralizing monetary authority at the Federal level.
d. Prior to the creation of the Federal Reserve System, the United States had no experience with central banks.
e. The existence of a strong central bank can reduce the number and the severity of bank runs in an economy.
f. Bank panics are not possible with a central bank.
g. The Federal Reserve System's organization is intended to spread financial power along regional lines, between the private sector and the government, and among bankers, businesspeople, and consumers.
h. The twelve Federal Reserve Banks set reserve requirements.
i. The twelve Federal Reserve Banks are all members of the Federal Open Market Committee.
j. Open market operations are directed by the Board of Governors.
k. There are three monetary policy tools: open market operations, reserve requirements, and the Federal funds rate, the interest rate that the Fed charges banks who borrow funds from the Fed.
l. An open market purchase by the Fed decreases the money supply.
m. The most important policy tool the Fed has for control of the money supply are its open market operations.
n. The Fed is a completely independent agency of the government.
o. The Fed should be an independent agency of the government.
p. Bureaucracies that work to serve the public interest are acting in accordance with the theory of bureaucratic behavior.
q. If the Fed's policies deviate too much from the desired policies of the legislature, it is possible that the legislature could pass laws that would alter the structure of the Fed.
r. The Fed often contributes to the political business cycle.
s. Countries with more independent central banks typically have better macroeconomic performance than do countries with less independent central banks.
t. An open market purchase by the Fed will, holding everything else constant, lead to a increase in interest rates.
u. The U.S. Treasury acts as the bank for the Federal Reserve System.
v. Total reserves is the sum of checkable deposits plus required reserves.
w. Total reserves is also the sum of required reserves plus excess reserves.
x. High-powered money is the same thing as reserves.
y. High-powered money is equal to the sum of currency plus reserves.
z. The monetary base is equal to high-powered money plus currency.
aa. Float is a name given to the process of check clearing.
bb. When the Fed makes an open market purchase from a bank this leads to an increase in the bank's reserves.
cc. When the Fed makes an open market sale to a bank this leads to an increase in the amount of currency in circulation.
dd. When the Fed makes an open market purchase from the nonblank public this may lead to an increase in reserves and/or an increase in currency.
ee. The Fed can control the level of reserves in the banking system better than it can control the monetary base.
ff. An increase in the monetary base, holding everything else constant, will lead to an increase in the money supply.
gg. The Fed can offset fluctuations in the monetary base due to fluctuations in float and Treasury deposits.
hh. People can change the monetary base when they purchase Treasury securities.
ii. A bank likes holding excess reserves since it helps them to cover deposit outflows.
jj. There is no cost to a bank of holding excess reserves.
kk. The failure to hold a sufficient level of excess reserves does not cost the bank.
ll. Holding excess reserves decreasing the expansion process from the money multiplier.
mm. An increase in the reserve requirement leads to a bigger money multiplier in the simple money multiplier model.
nn. The simple money multiplier does not model the possibility of currency drains or the possibility of excess reserves.
oo. An increase in the nonborrowed monetary base means that the Fed is engaging in open market sales.
pp. An increase in the nonborrowed monetary base will result in a decrease in the money multiplier.
qq. An increase in the discount rate will decrease discount loans and therefore the monetary base will decrease and this in turn will lead to a decrease in the money supply.
rr. When interest rates increase this leads to an increase in the excess reserve ratio for banks and an increase in the level of discount loans.
ss. In the long run the primary determinant of movements in the money supply is the borrowed monetary base, or in other words, the discount loans that the Fed makes.
tt. In the short run, the money multiplier is very constant and highly predictable.
uu. In the short run, the money multiplier fluctuates as does the currency ratio.
vv. In the Great Depression the Fed increased the money base enough 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. Essays and Problems
a. Using the simple money multiplier model: The Fed sells $100 of T-bills on the open market. What is the effect on the money supply if the reserve ratio is:
i. 10%
ii. 20%
iii. 50%
iv. 80%
b. Using the simple money multiplier model: The Fed buys $100 of T-bills on the open market. What is the effect on the money supply if the reserve ratio is:
i. 10%
ii. 20%
iii. 50%
iv. 80%
c. Mishkin p. 413. "In what ways can the regional Federal Reserve banks influence the conduct of monetary policy?"
d. Mishkin, p. 413. ‘ "The independence of the Fed has meant that is takes the long view and not the short view." Is this statement true, false, or uncertain? Explain your answer.