Question 1

If the Fed simultaneously raises the discount rate and the reserve requirement, the money supply will:

Accepted Answer

Raising the discount rate makes borrowing more expensive for banks, and increasing the reserve requirement reduces the amount of funds banks can lend out. Both actions lead to a contraction of the money supply.

Question 2

The federal funds rate is the interest rate the:

Accepted Answer

The federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight on an uncollateralized basis.

Question 3

The discount rate refers to the:

Accepted Answer

The discount rate is the interest rate the Federal Reserve charges commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility—the discount window.

Question 4

What tool of monetary policy would the Fed most likely use to increase the federal funds rate from 1 percent to 1.25 percent?

Accepted Answer

Open-market operations are the primary tool used by the Federal Reserve to influence the federal funds rate. By selling government securities, the Fed can decrease the money supply, leading to an increase in the federal funds rate.

Question 5

When the Fed sells bonds, the:

Accepted Answer

When the Federal Reserve sells bonds, it decreases the reserves that banks hold, which typically leads to an increase in the federal funds rate. This is because banks have less money to lend to each other, making the borrowing cost (federal funds rate) higher.

Question 6

Suppose the money multiplier in the United States is 3. Suppose further that if the Fed increases the discount rate by 1 percentage point, banks initially change their reserves by 400. To reduce the money supply by 4,200 the Fed should:

Accepted Answer

The money multiplier formula is $ \Delta M = m \times \Delta R $, where $ \Delta M $ is the change in the money supply, $ m $ is the money multiplier, and $ \Delta R $ is the change in reserves. To reduce the money supply by 4,200 with a multiplier of 3, the change in reserves needed is $ \Delta R = \frac{\Delta M}{m} = \frac{4200}{3} = 1400 $. Since a 1 percentage point increase in the discount rate initially changes reserves by 400, to achieve a change of 1400 in reserves, the discount rate needs to be raised by $ \frac{1400}{400} = 3.5 $ percentage points.

Question 7

Suppose the money multiplier in the United States is 3. Suppose further that if the Fed decreased the discount rate by 1 percentage point, banks change their reserves by 300. To increase the money supply by 2,700 the Fed should:

Accepted Answer

Given the money multiplier is 3, a change in reserves by 300 leads to a change in the money supply by 900 (300 * 3). To increase the money supply by 2,700, the Fed needs to increase reserves by 900 (2,700 / 3). Since a 1 percentage point change in the discount rate changes reserves by 300, a 3 percentage point change (900 / 300) is needed to achieve the desired increase in the money supply.

Question 8

Banks can borrow reserves from each other through:

Accepted Answer

The Fed funds market is where banks borrow reserves from each other. This market allows banks that have surplus reserves to lend to those with shortages, facilitating the efficient distribution of liquidity within the banking system.

Question 9

If the Fed simultaneously lowers the reserve requirement and sells government bonds, the money supply will:

Accepted Answer

Lowering the reserve requirement typically expands the money supply by allowing banks to lend more. Selling government bonds typically contracts the money supply by removing liquidity from the economy. These actions have opposing effects, making the net impact on the money supply indeterminate without more information.

Question 10

To decrease the nation's money supply, the Fed can:

Accepted Answer

Increasing the discount rate makes it more expensive for banks to borrow money from the Federal Reserve, leading to a decrease in the money supply as banks will likely lend less.

Question 11

The interest rate banks charge each other to borrow excess reserves is called the:

Accepted Answer

The federal funds rate is the interest rate at which depository institutions trade federal funds (balances held at Federal Reserve Banks) with each other overnight. This rate is crucial in the interbank market and influences other interest rates in the economy.

Question 12

The federal funds rate:

Accepted Answer

The federal funds rate can be targeted at zero, especially during periods of economic downturn to stimulate the economy, as seen during the 2008 financial crisis.

Question 13

The discount rate is the interest rate:

Accepted Answer

The discount rate is the interest rate the Federal Reserve (the Fed) charges on loans to commercial banks. This rate is set by the Fed and is a tool used to influence the supply of money in the U.S. economy.

Question 14

If the Fed simultaneously reduces the discount rate and the required reserve ratio, the money supply will:

Accepted Answer

Reducing the discount rate makes it cheaper for banks to borrow money from the Federal Reserve, encouraging them to increase their lending. Lowering the required reserve ratio allows banks to hold less cash in reserve and lend out a greater portion of their deposits. Both actions lead to an increase in the money supply.

Question 15

Although rarely used, which of the following is an instrument the Fed has to conduct monetary policy?

Accepted Answer

The discount rate is an instrument of monetary policy used by the Federal Reserve. It is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility.

Question 16

If the level of excess reserves in the banking system drops suddenly, we might expect that the:

Accepted Answer

When excess reserves in the banking system drop suddenly, banks have less liquidity available for lending, which increases the demand for overnight loans in the federal funds market. This increased demand for funds typically leads to a rise in the federal funds rate, as banks are willing to pay more to borrow reserves to meet their requirements.

Question 17

To increase the nation's money supply, the Fed can:

Accepted Answer

Decreasing the discount rate makes it cheaper for banks to borrow money from the Federal Reserve, encouraging them to increase lending to businesses and consumers, thereby increasing the money supply.

Question 18

Who buys and sells in the Fed funds market?

Accepted Answer

The Fed funds market is specifically for overnight borrowing and lending between commercial banks and depository institutions. This market allows these institutions to manage their reserve requirements. Other entities, like large corporations or individuals, do not participate directly in this market.

Question 19

When the Fed lowered the discount rate in late 2008, the action was ultimately designed to:

Accepted Answer

Lowering the discount rate makes it cheaper for banks to borrow money from the Federal Reserve, which encourages lending and increases the money supply in the economy.

Question 20

When the Fed reduces the discount rate, this sends a signal to banks that the Fed wants:

Accepted Answer

When the Fed reduces the discount rate, it lowers the cost for banks to borrow money from the Federal Reserve, encouraging them to increase lending. This action is intended to expand the money supply by making more funds available for banks to lend to businesses and consumers.

Quiz 29: Monetary Policy