Unit 13 Flashcards
What/Who is the central bank of the United States? A. Federal Reserve Bank B. Federal Reserve Districts C. Federal Reserve System D. Federal System E. Both C and A
E. Federal Reserve System and Federal Reserve Bank
What is the term given to the way in which the FRB executes their job?
monetary policy
Who is considered the founder of monetarism (or monetarist) theory?
a. John Maynard Keynes
b. Adam Smith
c. None listed
d. Milton Friedman
D. Milton Friedman, Ph.D, much of work of the Federal Reserve is based on his theories.
Rapid expansion of the economy is called?
Overheat
Give a definition of monetary policy
By managing the money supply: the amount of cash available within the U.S. economy
Explain the effect of expanding the money supply. Give the Pros and Cons.
Increasing the money supply expands the economy and creates jobs, it may trigger high levels of inflation.
What are some tools the FRB uses to curb high inflation?
Some of these tools are diagnostic tools and active tools
What are diagnostic tools used by FRB?
Those that “read” the economy. Another way to think of this is that diagnostic tools are like a ruler or a level, used to measure the economy.
Who is in charge of the Federal Reserve Bank ?
Federal Reserve Board (FRB)
What are active tools used by FRB?
Those that directly impact the economy. The active tools are a wrench, used to loosen or tighten the money supply.
What are the ways in which the money supply is measured?
M1, M2, and M3
What is M1 in money supply?
The measure of the most readily available money to spend: cash (actual cash and coinage) and money in demand deposit accounts (DDAs)
What is M3 in money supply?
Consists of M2 plus “large time deposits”—those assets that are a bit harder to move into a DDA and be spent
True or False
M3 is closest to being spent
False
M1 is the money that is closest to being spent and turned into economic activity.
What are the 2 main functions FRB?
■ Conduct the nation’s monetary policy to promote maximum employment.
■ Promote a stable price environment, keeping inflation under control.
What are examples of M3 in money supply?
Negotiable (jumbo) CDs and multiday repurchase agreements
What is an example of M1 in supply ?
checking accounts
True or False
M2 is part of M3
True
M2 is part of M3, so by extension is M1 because it is part of M2
Seabird Airlines has money in a long-term CD that it is saving to purchase a new airliner. When the CD matures, Seabird will deposit the money into a checking account in preparation for purchasing the new plane. What effect will this have on the money supply?
The funds are moved from M3 to M1, so M1 increases, but M3 does not change because the funds never left M3.
Explain M2 in money supply?
Consists of M1 plus “consumer savings deposits”—those assets that are easily move to a DDA and spent.
List various ways the FRB can influence money supply using active tools
Federal open-market operations
How does the Fed expands/loosen the money supply when they want to?
It buys securities from banks. The securities come out of the economy, and money goes into the economy through the bank.
What are some examples of M2 in money supply?
Among the “consumer savings deposits” are savings accounts, retail (non-negotiable) CDs, money market funds, and overnight repurchase agreements.
The increase of reserves (cash) allows banks to
make more loans and effectively lowers interest rates.
By buying securities, the Fed pumps money into the banking system. Explain how this affects the money supply and rates
expanding the money supply and reducing rates.
What is Federal open-market operations?
The FRB, acting as an agent for the U.S. Treasury Department, influences the money supply by buying and selling U.S. government securities (Treasury bills, notes, and bonds) in the open market.
How does the Fed contract/tighten the money supply when they want to?
it sells securities to banks. Now, cash comes out of the respective banks (to pay for the securities) and the securities go in as each sale is charged against a bank’s reserve (cash) balance.
What is the effect of using Federal open-market operations to influence money supply?
These actions will expand or contract the money supply, depending on which they are doing (buying or selling)
Who is the Federal Open Market Committee (FOMC)?
meets regularly to direct the government’s open-market operations
By selling securities, the Fed __________________. Explain based on the money supply and rates.
pulls money out of the system, contracting the money supply and increasing rates.
What is the effect of the FRB buying securities in the open market?
Securities come out of the economy, and money goes in. The money supply goes up, interest rates go down, borrowing and spending for consumers is easier, and the economy expands.
How does tightening a countries money supply affect the interest rate and loans?
This reduces the bank’s ability to lend money, which tightens credit and effectively raises interest rates.
What is the effect of the FRB selling securities in the open market?
Securities go into the economy, and money comes out. The money supply goes down, interest rates go up, borrowing and spending for consumers becomes more difficult, and the economy contracts.
Explain the Federal Funds Rate
is the rate that the commercial money center banks charge each other for overnight loans of $1 million or more
What is the prime rate?
is the interest rate that large U.S. money center commercial banks charge their most creditworthy corporate borrowers for unsecured loans.
True or False
All banks have the same prime rate
False
Each bank sets its own prime rate, with larger banks generally setting a rate that other banks use or follow
What is the cost of money?
Interest
Why is the federal funds rate considered a barometer of the direction of short term rates?
It is considered a barometer of the direction of short-term interest rates, which fluctuate constantly and can be considered the most volatile rate in the economy.
What determines the rate of interest?
In large measure, the supply and demand of money
Fill in the blanks
When the money available for loans exceeds demand, interest rates ____1_____; when the demand for money exceeds the supply, interest rates___2____.
- fall
2. rise
State what the reserve requirements means
is the amount a bank must maintain on deposit with the Federal Reserve.
What are the characteristics of Tight Money Policy ?
■ Sell U.S. government securities in the open market
■ Raise the discount rate
■ Raise reserve requirements
Which of the following is added to M2 to arrive at M3? A. Large time deposits
B. Currency in circulation
C. Checking accounts
D. Gold and silver bars in bank storage vaults
A
Which of the following actions of the Federal Reserve Board (FRB) would likely have the effect of causing interest rates to increase? I. The Federal Open Market Committee (FOMC) buying securities II. Raising the reserve requirements III. Raising the discount rate IV. Raising the prime rate A. I and II B. II and Ill C. II and IV D. III and IV
B
Which of the following rates is set by the Federal Reserve? A. Fed funds rate B. Discount rate C. Broker call rate D. Prime rate
B
What is a broker call loan rate?
Is the interest rate that banks charge BDs on money they borrow to lend to margin account customers.
What is the discount rate?
is the rate the Federal Reserve charges for short-term loans to member banks.
Give two alternative names for broker call loan rate
The broker loan rate is also known as the call loan rate or call money rate.
What does the discount rate indicate?
indicates the direction of FRB monetary policy
What does an increasing discount rate indicate?
an increasing rate indicates a tightening of FRB policy
Explain margin accounts?
allow customers to purchase securities without paying in full
State the meaning of a decreasing interest rate
a decreasing rate indicates an easing of FRB policy
When are broker call loan rate callable?
Broker call loans are callable on a 24-hour notice.
What are the four prominent interest rates ?
- Discount rates
- Broker call loan rate
- Federal funds rate
- Prime rate
If the FRB wants to ease its monetary policy to allow consumers to borrow more easily. What can it do to execute this and explain the effects?
it can lower the discount rate. This allows member banks to borrow from the FRB at a lower rate, which in turn allows consumers to borrow money at a lower rate from the member banks. Consumers’ ability to borrow at lower interest rates helps to fuel or push the economy forward because they are now in a position to purchase more goods and services.
What is Easy Money Policy?
To expand credit during a recession to stimulate a slow economy
When do banks lower and raise their prime rates?
Banks lower their prime rates when the FRB (or Fed) eases the money supply, and they raise rates when the Fed contracts the money supply.
What is the is seen as the base rate for the nation?
Discount rate
Reserves dropping below the reserve requirement number indicate _______________
that the bank may have insufficient cash to meet depositors’ demands.
Explain a repurchase agreement
the Fed holds some of the bank’s assets (usually loans the bank holds) as collateral for a short-term loan, usually overnight, though some times longer. This increases the bank’s cash reserves.
What is the effect of lowering reserve requirement number ?
frees up cash at the banks to fund loan activity, expanding the economy.
Give the characteristics of easy money policy
■ Buy U.S. government securities in the open market
■ Lower the discount rate
■ Lower reserve requirements
What is the effect of raising the reserve requirement as it relates to loans?
Raising this number decreases the amount available for loans.
The ____________ is the only rate of these four set by a unit of the federal government.
a. broker loan rate
b. prime rate
c. discount rate
d. federal funds rate
c. discount rate
Give a definition for discount rate
Banks that need additional capital to meet their reserve requirement may borrow money from the Federal Reserve System. The interest rate the Fed charges the bank is the discount rate
What is the purpose of a repurchase agreement?
Banks that need additional capital to meet their reserve requirement may borrow money from the Federal Reserve System. This is often done through a repurchase agreement
Raising the discount rate tends to_______________
lift interest rates throughout the economy
Why will raising the reserve requirement cause a decreases the amount available for loans?
Because changes in the reserve requirement have a dramatic impact throughout the banking system, hitting all the banks at once, the Fed rarely changes the reserve requirement.
lowering the discount rate tends to __________________
cause rates to drop.
What is Regulation T?
As part of the FRB’s regulatory authority, the Fed set the minimum amount an investor must deposit when using credit to buy a security.
What would cause a rise in stock prices under Regulation T?
If the FRB lowered the initial deposit requirement and allowed more borrowing, the extra cash available would likely raise stock prices
True or False
Under regulation T, increasing the amount required at purchase (thus limiting credit) would slow the economy.
True
Under Regulation T, the current 50% has been in place since ___.
a. 1964
b. 1993
c. 1974
d. 1990
c. 1974
What would be the effect of rise in stock prices under Regulation T?
This would result in more merger activity, as well as investors using the additional wealth to make purchases, expanding the economy
Under Regulation T, the current initial deposit is what percentage of the purchase price.
50%
