Question 1

The Fed's most important and most frequently used tool of monetary policy is

Accepted Answer

Open-market operations involve the buying and selling of government securities (usually through banks) by the Federal Reserve. This affects the money supply and interest rates in the economy, and is thus a powerful tool for controlling inflation and promoting economic growth. While changes in the discount rate and required reserve ratios are also used by the Fed, they are less frequently employed and typically have a smaller impact on the overall economy. Moral suasion refers to the use of persuasion and influence to encourage banks to behave in certain ways, but it is not a direct tool of monetary policy.

Question 2

When the Federal Reserve conducts open market transactions, it

Accepted Answer

When the Federal Reserve conducts open market transactions, it buys or sells previously issued government bonds. This is done to control the money supply and interest rates in the economy. When the Fed buys bonds, it injects money into the economy, increasing the money supply and lowering interest rates. When the Fed sells bonds, it reduces the money supply and raises interest rates.

Question 3

Open market transactions involve which of the following activities? 
I. issuing new Federal Reserve notes
II. buying or selling newly issued government bonds to raise funds for the government
III. buying or selling previously issued government bonds to change the volume of bank reserves

Accepted Answer

Open market transactions refer to the buying or selling of previously issued government bonds by the Federal Reserve to influence the level of bank reserves and control the money supply.

Question 4

The Federal Reserve buys $10,000 of government securities from commercial banks. If the required reserve ratio is 25%, what is the maximum amount of change in the nation's money supply? Assume that no banks keep excess reserves and no individuals or firms hold cash.

Accepted Answer

The maximum amount of change in the nation's money supply would be the reciprocal of the required reserve ratio multiplied by the initial injection of $10,000. Thus, 1/0.25($10,000) = $40,000. Therefore, the correct answer is option C.

Question 5

The Fed conducts an open market purchase of $10 million in government securities. If the reserve ratio is 20%, what is the maximum change in the money supply? Assume banks hold no excess reserves and there is no currency withdrawal from the banking system.

Accepted Answer

The maximum change in the money supply is determined by the simple money multiplier formula: 1/reserve ratio. In this case, the reserve ratio is 20%, so the simple money multiplier is 1/0.2 = 5. Therefore, the maximum increase in the money supply is $10 million x 5 = $50 million.

Question 6

Which of the following is an interest rate that is set directly by the Fed?

Accepted Answer

The discount rate, also known as the primary credit rate, is the interest rate at which banks can borrow money directly from the Federal Reserve. The Fed sets this rate as a tool for controlling the money supply and promoting stability in the banking system. The other options (A, B, and D) are influenced by the Fed but are not directly set by it. For example, the prime lending rate is set by individual banks based on their cost of funds, while the required reserve rate and federal funds rate are determined by market forces and influenced by the Fed's policies.

Question 7

Which of the following is a market in which banks lend reserves to one another?

Accepted Answer

The federal funds market is a market in which banks lend reserves to each other overnight. This allows banks to meet their reserve requirements and maintain liquidity. The other options listed do not involve interbank lending.

Question 8

The federal funds rate is determined

Accepted Answer

The federal funds rate is determined by the supply and demand for bank reserves. Banks borrow and lend money to meet their reserve requirements, and the interest rate at which they do so is the federal funds rate. The Federal Reserve can influence the federal funds rate through its monetary policy, but ultimately it is driven by the market forces of supply and demand.

Question 9

When the Fed purchases government bonds it _____ reserves and ____ the money supply.

Accepted Answer

The answer of When the Fed purchases government bonds it...

Question 10

If the Fed buys U.S. government bonds from the public, it

Accepted Answer

When the Fed buys U.S. government bonds from the public, it increases the volume of reserves in the banking system as the sellers of the bonds receive payment which goes into their bank accounts. This increases the overall supply of money in the economy, leading to economic growth. Therefore, the correct choice is A.

Question 11

The rate of interest charged for reserves in the federal funds market is the

Accepted Answer

The federal funds rate is the interest rate at which banks borrow and lend reserves in the federal funds market. It is determined by the supply and demand for reserves and is influenced by the actions of the Federal Reserve.

Question 12

The discount rate

Accepted Answer

The discount rate is set by the Board of Governors of the Federal Reserve System. It is the interest rate charged by the Federal Reserve to depository institutions on short-term loans. It is not determined by market forces or investment banks.

Question 13

Lowering the discount rate is

Accepted Answer

Lowering the discount rate reduces the cost for banks to borrow funds from the Fed, making it easier for them to lend money to consumers and businesses at lower interest rates. This encourages private spending and is an expansionary policy stance.

Question 14

Suppose the Fed purchases $1,000 of government securities from the general public who then deposit the proceeds into their checking accounts in commercial banks. Which pair of the T-accounts below shows this transaction?

Accepted Answer

The transaction involves two parties: the Fed and the general public. The Fed purchases $1,000 of government securities from the general public, which means the Fed's securities holdings increase by $1,000 and the general public's checking account balances increase by $1,000.
In the T-accounts, this transaction can be shown as follows:

Fed's balance sheet before the transaction:
Assets | Liabilities
------------|-----------
 Securities: $X  | Reserve balances: $Y

General public's balance sheet before the transaction:
Assets | Liabilities
------------|-----------
 Checking deposits: $Z  | Securities: $W

After the transaction, the T-accounts should show:

Fed's balance sheet after the transaction:
Assets | Liabilities
------------|-----------
 Securities: $X+$1,000  | Reserve balances: $Y+$1,000

General public's balance sheet after the transaction:
Assets | Liabilities
------------|-----------
 Checking deposits: $Z+$1,000  | Securities: $W-$1,000

Option B is the only T-account that correctly shows how the Fed's balance sheet and the general public's balance sheet are affected by the transaction.

Question 15

Suppose the reserve ratio is 25% and banks do not hold excess reserves. When the Fed sells $40 million of bonds to the public,

Accepted Answer

When the Fed sells $40 million of bonds to the public, bank reserves decrease by $40 million (since banks must have a reserve ratio of 25%, they must hold $10 million in reserves). This decrease in reserves could result in a decrease in the money supply by a maximum of $160 million (since banks can loan out the remaining $30 million, which could then be deposited in another bank and loaned out again, and so on, resulting in a potential maximum money supply decrease of 4 times the initial decrease in reserves).

Question 16

If the Fed raises its target for the federal fund rate, this indicates

Accepted Answer

When the Fed raises its target for the federal fund rate, it is pursuing a contractionary monetary policy. This is because it makes borrowing more expensive, which reduces the money supply and slows down economic growth, leading to lower inflation.

Question 17

The Fed can increase the federal funds rate by

Accepted Answer

The Fed can increase the federal funds rate by selling government securities, which decreases the money supply and reduces bank reserves. This, in turn, increases the cost of borrowing funds in the overnight interbank market, leading to an increase in the federal funds rate.

Question 18

Suppose the Fed conducts an open market sale of $50 million in government securities. If the required reserve ratio is 20%, what is the maximum change in the money supply? Assume that banks try not to hold excess reserves and there is no currency withdrawal from the banking system.

Accepted Answer

The answer of Suppose the Fed conducts an open market...

Question 19

The Federal Reserve influences the level of interest rates in the short run by changing the

Accepted Answer

The Federal Reserve influences the level of interest rates by changing the supply of money through open market operations. By buying government securities from banks, the Fed increases the reserves of banks, which in turn increases the supply of money in the economy. This leads to a decrease in interest rates in the short run as there is more money available to lend. Conversely, by selling government securities to banks, the Fed decreases the supply of money in the economy, leading to an increase in interest rates in the short run. Changes in reserve requirements and stock market operations have a more limited effect on interest rates in the short run.

Question 20

If the reserve ratio is 10%, and banks do not hold excess reserves, when the Fed purchases $10 million of government bonds, bank reserves

Accepted Answer

The answer of If the reserve ratio is 10%, and...

Quiz 9: The Nature and Creation of Money