Question 1

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

Accepted Answer

The discount rate is the interest rate that the Federal Reserve sets and offers to member banks for short-term loans. The other options are influenced or determined by market forces and decisions made by individual banks.

Question 2

The discount rate

Accepted Answer

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

Question 3

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

Accepted Answer

When the Fed purchases government bonds, it increases reserves of the banks, which in turn increases the lending capacity of banks. This leads to an increase in the money supply in the economy. Therefore, the correct answer is D - increases; increases.

Question 4

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. This occurs because when the public buys bonds from the Fed, they pay with their bank deposits, which decreases the banks' reserves. Since the reserve ratio is 25%, this decrease in reserves can lead to a decrease in the money supply by up to $160 million (4 times the amount of reserves lost). Therefore, the correct answer is D.

Question 5

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 answer of Suppose the Fed purchases $1,000 of government...

Question 6

The Fed can increase the federal funds rate by

Accepted Answer

When the Fed sells government securities, the banks have to pay for them, which decreases their reserves. This, in turn, increases the federal funds rate as banks have to borrow from each other to meet reserve requirements. Therefore, selling government securities decreases bank reserves, and increases the federal funds rate.

Question 7

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

Accepted Answer

Open-market operations involve buying and selling government securities in the open market to influence the supply of reserves in the banking system, which in turn affects interest rates and the level of economic activity. This tool is the most frequently used by the Federal Reserve to implement monetary policy. While moral suasion, changes in the discount rate, and changes in required reserve ratios can also be used by the Fed, they are less frequently used or less effective in achieving the desired policy goals.

Question 8

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 influence the supply of money, as buying bonds adds money to the economy and selling bonds removes money from the economy.

Question 9

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

An open market sale of $50 million in government securities by the Fed will remove this amount from the banking system. With a 20% reserve requirement, the maximum potential money creation (or in this case, reduction) is calculated using the money multiplier formula, which is 1/reserve ratio. Here, it's 1/0.20 = 5. Therefore, the maximum decrease in the money supply is $50 million * 5 = $250 million.

Question 10

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 10% reserve ratio and no excess reserves, this initial increase can support a total increase in the money supply of up to $100 million through the money multiplier effect.

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 that banks and other depository institutions charge each other for overnight loans made from their reserve balances held at the Federal Reserve. Therefore, the rate of interest charged for reserves in the federal funds market is the federal funds rate.

Question 12

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 monetary policy. This means that it is trying to slow down economic growth and combat inflationary pressures.

Question 13

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, where banks lend or borrow reserves from each other overnight. The Federal Reserve indirectly influences this rate by either decreasing or increasing the money supply through open market operations. The Board of Governors sets the target range for the federal funds rate, but the actual rate is determined by market forces. Households and firms' demands for funds can indirectly affect the federal funds rate through their impact on the overall demand for credit and money supply. The federal government does not directly determine the federal funds rate, but its fiscal policies and borrowing activities can indirectly influence it.

Question 14

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 pays for them with newly created reserves. This increases the volume of reserves in the banking system, leading to an increase in the money supply through the money multiplier effect. Therefore, choice A is the correct answer.

Question 15

Lowering the discount rate is

Accepted Answer

Lowering the discount rate is an expansionary monetary policy because it reduces the cost of borrowing funds for banks, making it easier for them to lend to consumers and businesses. This, in turn, puts downward pressure on interest rates in the economy, which can encourage private spending.

Question 16

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 money multiplier, which is the reciprocal of the reserve ratio.

Money Multiplier = 1/Reserve Ratio

In this case, the reserve ratio is 20%, so the money multiplier is:

Money Multiplier = 1/0.2 = 5

Therefore, the maximum change in the money supply would be:

Maximum Change in Money Supply = Money Multiplier x Change in Reserves

Maximum Change in Money Supply = 5 x $10 million = $50 million

Therefore, the correct answer is (C).

Question 17

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 specifically refer to the buying or selling of previously issued government bonds by the Federal Reserve to change the volume of bank reserves. Issuing new Federal Reserve notes and selling newly issued government bonds to raise funds for the government are not considered open market transactions.

Question 18

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

Accepted Answer

The Federal Reserve can influence the level of interest rates in the short run by changing the supply of money through open market operations. By buying or selling Treasury securities, the Fed can increase or decrease the amount of money available in the banking system, which will affect short-term interest rates. Changes in reserve requirements or stock market operations do not directly affect the supply of money and therefore are not effective tools for changing interest rates in the short run.

Question 19

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

Accepted Answer

The federal funds market is where banks lend reserves to one another overnight to meet the reserve requirement. The other options are not related to interbank lending.

Question 20

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

When the Federal Reserve buys government securities from commercial banks, the reserves of the banks increase. However, since the required reserve ratio is 25%, the banks must hold 25% of the $10,000 ($2,500) as required reserves and can lend out the remaining 75% ($7,500). This $7,500 can then be deposited into other banks, and those banks can also lend out 75% of it, continuing the cycle of money creation. The maximum amount of change in the nation's money supply is therefore the initial injection of $10,000 plus the amount created through the money multiplier effect, which in this case is $7,500/0.25 = $30,000. Therefore, the correct choice is C.

Quiz 9: The Nature and Creation of Money