Question 1

As the U.S. central bank, the Federal Reserve is owned and operated by the federal government.

Accepted Answer

The Federal Reserve, while overseen by the federal government, operates independently and is not "owned" by the government in the traditional sense. It is considered an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive or legislative branches of government.

Question 2

The Federal Open Market Committee is the Fed's most important policy-making body for controlling the growth of the money supply.

Accepted Answer

The Federal Open Market Committee (FOMC) is indeed the most important policy-making body of the Federal Reserve System, responsible for overseeing the nation's open market operations and thus playing a crucial role in influencing the money supply and the overall economic conditions.

Question 3

Although the Federal Reserve Banks are not motivated by profit, they do earn substantial revenues on the Fed's holdings of securities, and these revenues are largely turned over to the U.S. Treasury.

Accepted Answer

The Federal Reserve Banks earn interest on their holdings of U.S. government securities and on their loans to banks. These earnings are used to cover operating expenses and to pay dividends to member banks. The remainder, which is often substantial, is turned over to the U.S. Treasury, contributing to the federal government's budget.

Question 4

Most studies of central bank independence rank the Federal Reserve among the least independent in the world.

Accepted Answer

Most studies of central bank independence typically rank the Federal Reserve as one of the more independent central banks globally, due to its operational independence, control over monetary policy, and limited direct government intervention.

Question 5

The major functions of the Federal Reserve include controlling the money supply, serving as a lender of last resort, and regulating and supervising banks.

Accepted Answer

The Federal Reserve, as the central bank of the United States, has several key functions including controlling the money supply through monetary policy, serving as a lender of last resort to banks and other financial institutions in times of crisis, and regulating and supervising banks to ensure the safety and soundness of the financial system.

Question 6

The required reserve ratio is the most important and widely used monetary tool of the Federal Reserve.

Accepted Answer

The most important and widely used monetary tool of the Federal Reserve is open market operations, not the required reserve ratio.

Question 7

Compared to the discount rate and required reserve ratio, open market operations are the most flexible tool of monetary policy.

Accepted Answer

Open market operations, which involve the buying and selling of government securities in the open market to control the supply of money, are considered the most flexible tool of monetary policy because they can be adjusted quickly and implemented at the discretion of the central bank, unlike the discount rate and required reserve ratio which are less frequently changed and involve more regulatory processes.

Question 8

By lending funds to banks through its discount window during a crisis, the Federal Reserve attempts to protect the safety and soundness of the nation's financial system.

Accepted Answer

The Federal Reserve lends funds to banks through its discount window during a crisis to ensure liquidity, stabilize the banking system, and protect the overall safety and soundness of the nation's financial system. This mechanism helps prevent bank runs and fosters confidence in the financial system.

Question 9

Increasing the discount rate increases the money supply and decreasing the discount rate decreases the money supply.

Accepted Answer

Increasing the discount rate makes borrowing more expensive for banks, which typically reduces the money supply. Conversely, decreasing the discount rate makes borrowing cheaper for banks, which can increase the money supply.

Question 10

A lower required reserve ratio results in an increase in the money supply; a higher required reserve ratio results in a decrease in the money supply.

Accepted Answer

A lower required reserve ratio allows banks to lend out a larger portion of their deposits, thereby increasing the money supply. Conversely, a higher required reserve ratio means banks must hold a larger portion of deposits as reserves, reducing the amount they can lend out, which decreases the money supply.

Question 11

To combat a recession, the Federal Reserve would decrease the money supply and decrease the level of aggregate demand.

Accepted Answer

To combat a recession, the Federal Reserve would typically increase the money supply to lower interest rates and stimulate borrowing and spending, thereby increasing the level of aggregate demand.

Question 12

To combat inflation, the Federal Reserve would decrease the discount rate, decrease the required reserve ratio, or buy securities on the open market.

Accepted Answer

To combat inflation, the Federal Reserve would typically increase the discount rate, increase the required reserve ratio, or sell securities on the open market to decrease the money supply and raise interest rates, thereby slowing economic activity.

Question 13

During the stock market crash of 1987, the Fed reversed the crisis psychology by selling securities to banks and corporations.

Accepted Answer

During the stock market crash of 1987, the Fed actually eased the crisis by promising to supply liquidity to the banking system, not by selling securities to banks and corporations. This action reassured investors and helped to stabilize the financial markets.

Question 14

The discount rate is another name for the federal funds rate.

Accepted Answer

The discount rate is the interest rate the Federal Reserve charges commercial banks for short-term loans, while the federal funds rate is the interest rate at which banks lend reserves to each other overnight.

Question 15

If the Federal Reserve adopts a contractionary monetary policy, it increases domestic interest rates, which results in an increase in the exchange value of the dollar.

Accepted Answer

A contractionary monetary policy typically involves increasing interest rates to reduce inflation and slow economic growth. Higher interest rates attract foreign investors looking for higher returns on investments, which increases demand for the dollar, thereby increasing its exchange value.

Question 16

Proponents of the Federal Reserve maintain that the short-run compatibility between full employment and price stability enhances the Fed's ability to fine tune the economy.

Accepted Answer

The answer of Proponents of the Federal Reserve maintain that...

Question 17

The Federal Reserve is required by law to focus mainly on controlling unemployment.

Accepted Answer

The Federal Reserve is mandated by law to focus on both maximum employment and stable prices, not solely on controlling unemployment.

Question 18

To combat the recession of 2001, the Federal Reserve rapidly increased the money supply and lowered interest rates.

Accepted Answer

To combat the recession of 2001, the Federal Reserve indeed lowered interest rates and increased the money supply as part of its monetary policy to stimulate economic growth by making borrowing cheaper and increasing liquidity in the economy.

Question 19

Critics argue that because of timing lags and a lack of knowledge about the economy, the Federal Reserve should terminate its activist monetary policies and increase the supply of money each year at a constant rate.

Accepted Answer

Critics argue that the Federal Reserve's activist monetary policies can be ineffective or counterproductive due to timing lags and insufficient knowledge about the economy's current state and future direction. They suggest a rule-based approach, such as increasing the money supply at a constant rate, to provide stability and predictability.

Question 20

The main argument for Federal Reserve independence is that monetary policy-which affects inflation, employment, growth, and exchange rates-is too important to be determined by politicians.

Accepted Answer

The main argument for Federal Reserve independence is indeed that monetary policy decisions, which have significant impacts on inflation, employment, economic growth, and exchange rates, should be insulated from political pressures to ensure they are made based on economic considerations rather than political expediency.

Quiz 15: The Federal Reserve and Monetary Policy