Deck 15: The Tools of Monetary Policy

Question 1

Go to http://www.federalreserve.gov/fomc/. This site reports activity by the FOMC. Scroll down to Calendar and click on the statement released after the most recent FOMC meeting. Summarize this statement in one paragraph. Be sure to note what the committee decided to do to the federal funds rate target. Now review the statements from the past two meetings. Has the stance of the committee changed?

Answer 1

Not Answer

Question 2

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"If reserve requirements were eliminated, it would be harder to control interest rates." Is this statement true, false, or uncertain?

Answer 2

Evaluating whether reserve requirements will make control of interest rates difficult :
Eliminating reserve requirements will not make it hard to control interest rates. In fact interest rates are mostly controlled by the Fed using open market operations.
The reserve requirement tool is not used for controlling interest rates for the following reasons:
(1) Reserve requirements are no longer binding for most banks, so this tool is much less effective than it once was. For instance, banks sweep their deposits every night into repurchase agreements in order to reduce their required reserve balances.
(2) Raising reserve requirements can cause immediate liquidity problems for banks where reserve requirements are binding. When the Fed increased these requirements in the past, it usually softened the blow by conducting open market purchases or making the discount window more available, thereby providing reserves to banks that needed them.
(3) Continually fluctuating reserve requirements also create uncertainty for banks and make their liquidity management difficult.

Question 3

During the holiday season, when the public's holdings of currency increase, what defensive open market operations typically occur? Why?

Answer 3

The Fed will conduct expansionary monetary policy when the public decides to hold more currency during the holiday season. This means that the Fed will increase the money supply to make up for the reduction in currency circulation in order to control short-term interest rates. To do so, from banks so that there will be an injection of funds into the financial system to make up for the shortage of funds in circulation.

Question 4

How can poorly designed compensation schemes in financial service firms lead to conflicts of interest?

Question 5

Go to http://www.federalreserve.gov/releases/h15/update/. What is the current federal funds rate? What is the current Federal 'Reserve discount rate? (Define this rate as well.) Have short-term rates increased or decreased since the end of 2008?

Question 6

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Compare the use of open market operations, loans to financial institutions, and changes in reserve requirements to control the money supply on the basis of the following criteria: flexibility, reversibility, effectiveness, and speed of implementation.

Question 7

If the Treasury' pays a large bill to defense contractors and as a result its deposits with the Fed fall, what defensive open market operations will the manager of the open market desk undertake?

Question 8

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

Question 9

If float decreases to below its normal level, why might the manager of domestic operations consider it more desirable to use repurchase agreements to affect the monetary' base, rather than an outright purchase of bonds?

Question 10

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?

Question 11

"The only way that the Fed can affect the level of borrowed reserves is by adjusting the discount rate." Is this statement true, false, or uncertain? Explain your answer.

Question 12

Why is the composition of the Fed's balance sheet a potentially important aspect of monetary policy during an economic crisis?

Question 13

"The federal funds rate can never be above the discount rate." Is this statement true, false, or uncertain? Explain your answer.

Question 14

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

Question 15

"The federal funds rate can never be below the interest rate paid on reserves." Is this statement true, false, or uncertain? Explain your answer.

Question 16

If a switch occurs from deposits into currency, what happens to the federal funds rate? Use the supply and demand analysis of the market for reserves to explain your answer.

Question 17

Why is paying interest on reserves an important tool for the Federal Reserve in managing crises?

Question 18

Why is it that a decrease in the discount rate does not normally lead to an increase in borrowed reserves? Use the supply and demand analysis of the market for reserves to explain.

Question 19

Why are repurchase agreements used to conduct most short-term monetary policy operations, rather than the simple, outright purchase and sale of securities?

Question 20

Using the supply and demand analysis of the market for resemes, indicate what happens to the federal funds rate, borrowed reserves, and nonborrowed resemes, holding everything else constant, under the following situations.
a. The economy is surprisingly strong, leading to an increase in the amount of checkable deposits.
b. Banks expect an unusually large increase in withdrawals from checking deposit accounts in the future.
c. The Fed raises the target federal funds rate.
d. The Fed raises the interest rate on reserves above the current equilibrium federal funds rate.
e. The Fed reduces reserve requirements.
f. The Fed reduces reseme requirements and then offsets this action by conducting an open market sale of securities.

Question 21

Open market operations are typically repurchase agreements. What does this tell you about the likely volume of defensive open market operations relative to the volume of dynamic open market operations?

Question 22

Following the global financial crisis in 2008, assets on the Federal Reserve's balance sheet increased dramatically, from approximately $800 billion at the end of 2007 to $3 trillion by 2011. Many of the assets held are longer-term securities acquired through various loan programs instituted as a result of the crisis. In this situation, how could reverse repos (matched sale-purchase transactions) help the Fed reduce its assets held in an orderly fashion, while reducing potential inflationary problems in the future?

Question 23

"Discount loans are no longer needed because the presence of the FD1C eliminates the possibility of bank panics." Is this statement true, false, or uncertain?

Question 24

What are the disadvantages of using loans to financial institutions to prevent bank panics?

Question 25

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You often read in the newspaper that the Fed has just lowered the discount rate. Does this signal that the Fed is moving to a more expansionary monetary policy? Why or why not?

Question 26

If the manager of the open market desk hears that a snowstorm is about to strike New York City, making it difficult to present checks for payment there and so raising the float, what defensive open market operations will the manager undertake?

Question 27

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How can the procyclical movement of interest rates (rising during business cycle expansions and falling during business cycle contractions) lead to a procyclical movement in the money supply as a result of Fed discount loans? Why might this movement of the money supply be undesirable?