Question 1

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 indicating that it is pursuing a contractionary or restrictive monetary policy. This is because raising the federal fund rate makes borrowing more expensive, which can slow down economic growth and help prevent inflation.

Question 2

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

In this transaction, the Fed is buying government securities from the general public, so the Fed's securities account increases by $1,000, while the public's checking account increases by $1,000. When the public deposits the proceeds into their checking accounts in commercial banks, the commercial bank's reserves increase by $1,000, and the public's checking account increases. This can be seen in the T-accounts in Choice B, where the Fed's Securities account and the Public's Checking account both increase by $1,000, while the assets of Bank A increase by $1,000 (and so does its reserves). The assets of Bank A increase because it receives a deposit of $1,000, and its liabilities also increase because it owes the public money.

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 money supply and bank reserves, not issuing new notes or raising funds for the government.

Question 4

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 depository institutions (banks) lend and borrow balances overnight from one another in the federal funds market. It is the rate at which banks can borrow reserves from other banks.

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 can be calculated using the simple money multiplier formula: 1/RR (where RR is the reserve ratio). In this case, the reserve ratio is 20%, so the money multiplier is 1/0.2 = 5. Therefore, the maximum increase in the money supply is $10 million x 5 = $50 million.

Question 6

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 money multiplier is 1/0.2 = 5. An open market sale decreases reserves by $50 million, leading to a maximum decrease in the money supply of $50 million * 5 = $250 million.

Question 7

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 is determined by the money multiplier formula: change in money supply = (1/reserve ratio) x initial change in reserves. In this case, the initial change in reserves is $10,000 and the reserve ratio is 25%, so the money multiplier is 1/0.25 = 4. Therefore, the maximum change in the money supply is $10,000 x 4 = $40,000, which is option C.

Question 8

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

When the Fed purchases $10 million of government bonds, bank reserves increase by $10 million. With a reserve ratio of 10%, the money multiplier is 1/0.10 = 10. Therefore, the money supply could eventually increase by $10 million * 10 = $100 million.

Question 9

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, which can encourage banks to lend more money. This increase in lending can lead to an expansion of the money supply. Therefore, choice A is the correct answer. Choices B, C, and D are incorrect because they suggest a decrease in reserves or a fall in the money supply, which is not the expected outcome when the Fed buys government bonds.

Question 10

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 one another. The required reserve market and open market refer to different types of reserve requirements and monetary policy operations, while the discount market refers to a market in which banks can borrow from the Federal Reserve at the discount rate.

Question 11

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 in the open market in order to adjust the reserves held by banks, which in turn affects the supply and demand of money and interest rates. This is the Fed's most frequently used tool of monetary policy. Moral suasion involves using persuasion and informal influence to try to change behavior, and changes in the discount rate or required reserve ratios are less frequently used tools of monetary policy.

Question 12

The federal funds rate is determined

Accepted Answer

The federal funds rate is determined by the supply and demand for bank reserves in the federal funds market. The Federal Reserve influences this rate but does not directly control it. The Board of Governors, households, firms, and the federal government all have some influence on the economy and the financial system, but they do not directly determine the federal funds rate.

Question 13

Lowering the discount rate is

Accepted Answer

Lowering the discount rate is an expansionary policy stance because it makes it less costly for banks to borrow funds from the Fed, which in turn puts downward pressure on interest rates in the economy. This encourages private spending by making borrowing more affordable for consumers and businesses.

Question 14

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

Accepted Answer

The discount rate is the interest rate at which banks can borrow directly from the Federal Reserve. The Fed sets this rate directly. The prime lending rate and federal funds rate are influenced by the Fed's actions but are set by individual banks. The required reserve rate refers to the amount of money banks are required to hold in reserve and is set by the Fed but is not an interest rate.

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 the reserve ratio is 25%, this decrease in reserves can result in a maximum decrease in the money supply of 4 times the initial amount of reserves, which is $160 million. Therefore, the money supply could decrease by a maximum of $160 million.

Question 16

The Fed can increase the federal funds rate by

Accepted Answer

Selling government securities decreases bank reserves, which makes it more expensive for banks to borrow from each other and thus increases the federal funds rate. Buying government securities increases bank reserves and makes it cheaper for banks to borrow, which would decrease the federal funds rate.

Question 17

The discount rate

Accepted Answer

The discount rate is set by the Board of Governors of the Federal Reserve System. It is not determined by market forces of demand and supply or investment banks.

Question 18

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

Accepted Answer

The Federal Reserve can directly influence the supply of money through open market operations, such as buying or selling government bonds. When the Fed buys bonds, they increase the money supply, which in turn can lower interest rates in the short run. The demand for money is primarily determined by economic activity and consumer preferences, and the Fed can indirectly affect it through changes in the money supply. However, reserve requirements and stock market operations are not primary tools used by the Fed to influence interest rates.

Question 19

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 in order to affect the money supply and interest rates in the economy. By buying government bonds, the Fed injects money into the economy, while selling bonds takes money out of circulation. This can have an impact on interest rates and inflation.

Question 20

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

Accepted Answer

When the Fed purchases government bonds, it increases bank reserves and the money supply by injecting money into the banking system.

Quiz 9: The Nature and Creation of Money