PRINCIPLES OF MACROECONOMICS(LOOSELEAF)
7th Edition
ISBN: 9781260110920
Author: Frank
Publisher: MCG
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Chapter 10, Problem 6P
To determine
Determine which of the given statement is false about the Fed.
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The Federal Reserve Board of Governors has the power to raise or lower short-term interest rates. Between 2005 and 2006, the Fed aggressively increased the benchmark federal funds interest rate from 2.5 percent in February 2005 to 5.25 percent in June 2006, where it remained until July 2007. From July 2007 to December 2008, the Fed rapidly decreased the federal funds rate, where it dropped to 0.16 percent and remained between 0.07 percent and 0.20 percent through November 2015, after which it again began to rise. Assuming that other interest rates also increased and then decreased along with the federal funds rate, what effects do you think those moves had on investment spending in the economy? Explain your answer. What do you think the Fed’s objective was in increasing and then decreasing the federal funds rate? When and why might the Fed decide to start raising the federal funds rate?
Bank Three currently has $600 million in transaction deposits on its balance sheet. The Federal Reserve has currently set the reserve requirement at 10 percent of transaction deposits. (LG 4-3)
If the Federal Reserve decreases the reserve requirement to 8 percent, show the balance sheet of Bank Three and the Federal Reserve System just before and after the full effect of the reserve requirement change. Assume Bank Three withdraws all excess reserves and gives out loans and that borrowers eventually return all of these funds to Bank Three in the form of transaction deposits.
Redo part (a) using a 12 percent reserve requirement.
Article Summary
In a September 2013 speech to the Independent Bankers Association of Texas, Federal Reserve Bank of Dallas president Richard Fisher stated that the Fed's credibility was harmed when it announced the previous week that it would continue its large bond purchasing program. In June, Fed Chairman Ben Bernanke had stated that that the program could begin to be cut back later in the year, and several other Fed officials expressed being open to the announced timing of this policy. Bernanke's change in his announced timeline of the Fed's intentions regarding the bond purchasing program brought criticism that the Fed had misled investors. In his speech, Fisher stated "I disagreed with the decision of the committee and argued against it. Doing nothing at this meeting would increase uncertainty about the future conduct of policy and call the credibility of our communications into question. I believe that is exactly what has occurred, though I take no…
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PRINCIPLES OF MACROECONOMICS(LOOSELEAF)
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- Bank Three currently has $600 million in transaction deposits on its balance sheet. The Federal Reserve has currently set the reserve requirement at 10 percent of transaction deposits. If the Federal Reserve decreases the reserve requirement to 8 percent, show the balance sheet of Bank Three and the Federal Reserve System just before and after the full effect of the reserve requirement change. Assume Bank Three withdraws all excess reserves and gives out loans and that borrowers eventually return all of these funds to Bank Three in the form of transaction deposits.arrow_forwardOne effect of the September 11, 2001, terrorist attacks was to temporarily prevent banks from accessing reserves they needed to meet the demands of their customers. (This occurred because the attacks destroyed many records as well as the computers required to access backup records, and it took affected banks several weeks to become fully operational.) In response, the Fed made many billions of dollars of reserves available to banks, gradually withdrawing the new reserves from the banking system as that system returned to normal. Suppose the Fed had not injected reserves in this way. What would likely have happened to interest rates as a result? What would have been the likely impact on the stock market and on spending by consumers and businesses? Would the unemployment rate have gone up or down? Explain your reasoning in each case.arrow_forwardWhen the Fed embarked on a policy known as quantitative easing, they slowly lowered the federal funds rate target until it was equal to zero. they reduced the required reserve ration by one-quarter point per month for 12 months. bought longer-term securities than are usually bought in open market operations. opened up lending to primary dealers, commercial banks, and investment banks.arrow_forward
- While a television news reporter might state that “Today the Fed lowered the federal funds rate from 5.5 percent to 5.25 percent,” a more precise account of the Fed’s action would be as follows: “Today the Fed told its bond traders to conduct open-market operations in such a way that the equilibrium federal funds rate would decrease to 5.25 percent.” “Today the Fed lowered the discount rate by a quarter of a percentage point, and this action will force the federal funds rate to drop by the same amount.” “Today the Fed took steps to decrease the money supply by an amount that is sufficient to decrease the federal funds rate to 5.25 percent.” “Today the Fed took a step toward contracting aggregate demand, and this was done by lowering the federal funds rate to 5.25 percent.”arrow_forwardWhich of the following monetary tools is the Fed most likely to use for carrying out its day-to-day management of the money supply? Changes in the discount rate Changes in the reserve requirement Changes in tax rates Open market operationsarrow_forwardIn 2003, as the U.S. economy finally seemed poised to exit its ongoing recession, the Fed began to worry about a “soft patch” in the economy, in particular the possibility of a deflation. As a result, the Fed proactively lowered the federal funds rate from 1.75% in late 2002 to 1% by mid-2003, the lowest federal funds rate on record up to that point in time. In addition, the Fed committed to keeping the federal funds rate at this level for a considerable period of time. This policy was considered highly expansionary and was seen by some as potentially inflationary and unnecessary. a. How might fears of a zero lower bound justify such a policy, even if the economy was not actually in a recession? b. Show the impact of these policies on the MP curve and the AD/AS graph. Be sure to show the initial conditions in 2003 and the impact of the policy on the deflation threat.arrow_forward
- The initial condition of the banking system is as follows: $500 billion in reserve, $4,500 billion in loans and investments, and 5,000 billion in deposits. The required reserve is 10%. The Fed buys $100 billion government securities using open market operation, and lowers the reserve requirement to 5%. The banking system converts 85% excess reserves to loans, but borrowers return only 65% of these funds to the banking system as deposits. What is the maximum amount of loans in the banking system as a result of such Fed operation?arrow_forwardOne of the major functions of commercial banks is credit creation. Commercial banks create credit by advancing loans and purchasing securities. They lend money to individuals and businesses out of deposits accepted from the public. Commercial banks have to maintain a specified percentage of their deposits as liquidity which is set by the central bank. This reserve requirement controls the extent to which commercial banks can grow money in the economy. Assuming you only have one commercial bank in your economy, a reserve requirement of 20% and an initial deposit of 200. REQUIRED: A. Show for the first four days and the last day the balance sheet of your commercial bank.arrow_forwardWhich of the following can be described accurately as “policy rates adjusted by the Fed?” (a) federal funds rate and interest on excess reserves; (b) discount rate and prime rate; (c) 31-day Treasury bill rate and the 30-year Treasury bond rate; (d) discount rate and 30-year mortgage interest ratearrow_forward
- BSW Bank currently has $150 million in transaction deposits on its balance sheet. The Federal Reserve has currently set the reserve requirement at 10 percent of transaction deposits. iIf the Federal Reserve decreases the reserve requirement to 6 percent, show the balance sheet of BSW and the Federal Reserve System just before and after the full effect of the reserve requirement change. Assume BSW withdraws all excess reserves and gives out loans and that borrowers eventually return all of these funds to BSW in the form of transaction deposits.arrow_forwardIn order to promote digitalization of Indian banking system, the government encourages banks to open more ATMs in rural India, making withdrawals from bank accounts more convenient. Assume the RBI does not change the money supply.arrow_forwardBased on Keynesian economic theory, which of the following will occur if the Central Bank increases the money supply? Select one: The price level will rise while the real rate of interest and the level of investment remains unchanged The real rate of interest will fall and as such investment will increase Aggregate demand will fall as prices rise The nominal rate of interest will fall but the real rate of interest will also fall as the price level falls. As a result, investment remains unchangedarrow_forward
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