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Money Banking and Financial Markets 4th edition Stephen Cecchetti, Kermit Schoenholtz - Solutions
Currently, all the national central banks in the Euro system are involved with the day-to-day implementation of monetary policy. What do you think the advantage would be of centralizing the conduct of these day-to-day interactions with financial markets at the ECB in Frankfurt? Are there any
In 2012, the FOMC stated for the first time that it aims at an inflation rate of 2 percent (based on the price index of personal consumption expenditures). How might this announcement help secure price stability?
Do you think the members of the ECB’s Governing Council should take formal votes? Why or why not? If they do vote, how do you think the votes should be allocated?
Do you think, in the interest of transparency, the Chair of the Federal Reserve Board should explain in detail the subtleties surrounding policy decisions? Why or why not?
If you were asked to design a new central bank, what two institutional design features of (a) the Federal Reserve System and (b) the ECB would you adopt? Explain your choices.
Go to the Federal Reserve Board's Web site and locate the FOMC’s most recent statement. What did the committee members say at their last meeting regarding the Federal funds target and the two goals of price stability and sustainable economic growth?
Some people have argued that the high inflation of the late 1970s was a consequence of the fact that Federal Reserve Board Chairman Arthur Burns did what President Richard Nixon wanted him to do. What policy do you think Nixon might have wanted?
How might the ECB’s pursuit of price stability as its primary objective restrict its response to the sovereign debt crisis in the euro zone?
Why did the “no-bailout” clause of the Maastricht Treaty come under stress during the financial crisis of 2007-2009?
Do you think the current procedures for appointing members to the Board of Governors are consistent with the principles of good central bank design? Explain your answer.
Why do you think the statement released after each Federal Open Market Committee meeting retains the same basic structure?
How large are the public debt burdens of key euro-area economies? Are they rising or falling? Plot without recession bars the debt-to-GDP ratios of Germany (FRED code: GGGDTADEA188N), Italy (FRED code: GGGDTAITA188N) and the euro area as a whole (FRED code: GGGDTAEZA188N). Extend each line using
The European Central Bank (ECB) has translated its primary objective of price stability into an explicit, quantitative goal of keeping euro-area annual inflation close to, but below, 2 percent over the medium term. Plot the percent change from a year ago of the euro-area price level (FRED code:
In 2012, the Federal Reserve announced an inflation objective of 2 percent “over the longer run” for the price index of personal consumption expenditures (FRED code: PCEPI). However, many analysts focus on the “core” price index (FRED code: PCEPILFE), which omits the volatile food and
The FOMC statement of December 12, 2012, indicated that the target range for the federal funds rate would continue at least until the rate of unemployment falls below 6½ percent or the projected rate of inflation one to two years ahead exceeds the FOMC’s two-percent objective by one-half
In August 2007 and in March 2008, the Federal Reserve Board reduced the discount rate to ease liquidity conditions for banks. Plot discount window borrowing (FRED code: DISCBORR) between January 2007 and December 2008. As a second line, plot on the right axis the difference between the discount
Follow the impact of a $100 cash withdrawal through the entire banking system, assuming that the reserve requirement is 10 percent and that banks have no desire to hold excess reserves.
Suppose a major bank needs to borrow $20 billion overnight that it cannot obtain from private creditors. The Fed is willing to make a discount loan of $20 billion provided that it will not alter interbank lending rates. How can it do so?
Does theFederal Reserve frequently purchase or sell gold or foreign exchange as part of its efforts to change the money supply?
When you withdraw cash from your bank’s ATM, what happens to the size of the Fed’s balance sheet? Is there any reason for the Fed to react to your action?
How did the financial crisis of 2007-2009 affect the size and composition of the balance sheet of the Federal Reserve?
Suppose the currency-to-deposit ratio is 0.25, the excess reserve-to-deposit ratio is0.05, and the required reserve ratio is 0.10. Which will have a larger impact on the money multiplier: a rise of 0.05 in the currency ratio or in the excess reserves ratio?
Is the money-multiplier model still useful for policymakers? If not, why not?
Based on Figure explain why the multipliers fell sharply with the onset of the financial crisis of 2007-2009. Why did they remain at this lower level after the crisis ended?
Explain how an incomplete understanding at the Federal Reserve of the relationship between the central bank’s balance sheet and the money supply contributed to the Great Depression. How did the Fed’s behavior during the financial crisis of 2007-2009 illustrate that it had learned a valuable
In which of the following cases will the size of the central bank’s balance sheet change? a. The Federal Reserve conducts an open market purchase of $100 million U.S. Treasury securities.b. A commercial bank borrows $100 million from the Federal Reserve.c. The amount of cash in the vaults of
You pick up the morning newspaper and note a headline reporting a major scandal about the Federal Deposit Insurance Corporation that is likely to undermine the public’s confidence in the banking system. What impact, if any, do you think this scandal might have on the relationship between the
Compute the impact on the money multiplier of an increase in the currency-to-deposit ratio from 10 percent to 15 percent when the reserve requirement is 10 percent of deposits, and banks’ desired excess reserves are 3 percent of deposits.
Consider an open market purchase by the Fed of $3 billion of Treasury bonds. What is the impact of the purchase on the bank from which the Fed bought the securities? Compute the impact on M1 assuming that:(1) The required reserve ratio is 10 percent; (2) The bank does not wish to hold excess
*Why is currency circulating in the hands of the nonbank public considered a liability of the central bank?
The U.S. Treasury maintains accounts at commercial banks. What would be the consequences for the money supply if the Treasury shifted funds from one of those banks to the Fed?
Suppose you examine the central bank’s balance sheet and observe that since the previous day, reserves had fallen by $100 million. In addition, on the asset side of the central bank’s balance sheet, securities had fallen by $100 million. What activity did the central bank carry out earlier in
Do you think the central bank was aiming to increase, decrease, or maintain the size of the money supply by carrying out the changes described to its balance sheet in Problem14? Explain your answer.
Looking again at the situation described in Problem14, do you think the size of the banking system’s balance sheet would be affected immediately by these changes to the central bank’s balance sheet? Explain your answer.
Do you think the Federal Reserve successfully carried out its role as lender of last resort in the wake of the terrorist attacks on September 11, 2001? Why or why not?
In carrying out open market operations, the Federal Reserve buys and sells U.S. Treasury securities. Suppose the U.S. government paid off all its debt. Could the Federal Reserve continue to carry out open market operations?
Plot on a weekly basis the ratio of currency (FRED code: CURRENCY) to checkable deposits (FRED code: TCD) from the start of 2000 through 2002. Download the data and identify the week of the downward spike in the graph. Do you think the spike reflects the currency term in the numerator or the
In the Great Depression, the Fed allowed the money supply to decline. To confirm that the Federal Reserve learned from this lesson, plot since 2000 the M2 multiplier – the ratio of M2 (FRED code: M2SL) to the monetary base (FRED code: AMBSL) and, on the right axis, the level of M2. Explain how
Prior to the financial crisis of 2007-2009, the Fed seldom reduced its holdings of Treasury securities. Plot for the 2007-2009 period the Fed’s Treasury holdings (FRED code: TREAST) and its total assets (FRED code: WALCL) on a weekly basis. Did the Fed’s practices change during the crisis? If
Thousands of the data series on FRED are provided directly by the Board of Governors of the Federal Reserve System, including hundreds of indicators from the Fed’s weekly balance sheet report (H.4.1 Factors Affecting Reserve Balances).How does this balance sheet transparency affect the conduct
Figure 17.11 shows a sharp decline of the M1 money multiplier in 2008. What caused the drop? Using the indicators for currency (FRED code: CURRENCY), total reserve balances maintained (FRED code: RESBALNS), reserve balances required (FRED code: RESBALREQ), and checkable deposits (FRED code: TCDSL),
Suppose, one morning the Open Market Trading Desk drastically underestimates the demand for reserves when deciding the quantity of reserves to supply to the market. Based on analysis of the market for bank reserves, explain why the market federal funds rate will not exceed the discount rate
Suppose the Federal Reserve did not pay interest on excess reserves. How would the reserve demand curve differ from that in Figure?
In a graph of the market for bank reserves, show how the Federal Reserve limits deviations of the market federal funds rate from its interest rate target under the channel system. Next, show how the Open Market Trading Desk would implement a decision by the FOMC to raise the target federal funds
From 1979 to 1982, the FOMC used money growth as an intermediate target. To do so, the committee instructed the Open Market Trading Desk to target the level of reserves in the banking system. What was the justification for doing so? Explain why the result was unstable interest rates. Would you
Federal Reserve buying of mortgage-backed securities is an example of atargeted asset purchase. Explain how the Fed’s actions are intended to work.
The strategy of inflation targeting, which seeks to keep inflation close to a numerical goal over a reasonable horizon, has been referred to as a policy of “constrained discretion.” What does this mean?
The charge given by Congress to the Federal Reserve is to “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Discuss whether the Taylor rule conforms to this mandate.
Discuss the coefficients on the inflation gap and output gap terms in the Taylor rule given in equation (1). If you could change the relative importance of the coefficients, what would you choose?
Use the following Taylor rule to calculate what would happen to the real interest rate if actual and expected inflation increased by 3 percentage points. Target federal funds rate = 2 + current inflation + ½(inflation gap) +½(output gap)
The Taylor rule in question 19 is thought to be a reasonably good description of policy behavior in the United States in the absence of unusual financial market conditions or deflationary worries. Taking into account what you know about the policy goals of the ECB and that the average economic
Go to the Web site of the Federal Reserve Board at www.federalreserve.gov and find the section describing monetary policy tools. Which unconventional tools employed during the financial crisis of 2007-2009 has the Fed stopped using? What do you think determined the order in which various facilities
Use your knowledge of the problems associated with asymmetric information to explain why, prior to the change in the Federal Reserve’s discount lending facility in 2002, banks were extremely unlikely to borrow from the facility despite funds being available at a rate below the target federal
The ECB pays a market-based interest rate on required reserves and a lower rate on excess reserves. Explain why the system is structured this way.
Based on the liquidity premium theory of the term structure of interest rates, explain how forward guidance about monetary policy can lower long-term interest rates today. Be sure to account for both future short-term rates and for the risk premium. How does the effectiveness of forward guidance
With the policy interest rate at zero, how might a central bank counter unwanted deflation?
Outline and compare the ways in which the Federal Reserve and the ECB added to or adjusted their monetary policy tools in response to the financial crisis of 2007-2009 and subsequent financial crisis in the euro area.
The central bank of a country facing economic and financial market difficulties asks for your advice. The bank hit the zero bound with its policy interest rate but it wasn’t enough to stabilize the economy. Drawing on the actions taken by the Federal Reserve during the financial crisis of
Suppose ECB officials ask your opinion about their operational framework for monetary policy. You respond by commenting on their success at keeping short-term interest rates close to target but also express concern about the complexity of their process for managing the supply of reserves. What
Consider a situation where reserve requirements are binding and the Federal Reserve decides to reduce the requirements. How would the Open Market Trading Desk act to maintain the interest rate target, assuming the demand for excess reserves remains unchanged?
How might the Federal Reserve exit from the unconventional policies it employed during the financial crisis of 2007-2009 without causing inflationary problems?
Plot the Taylor Rule since 1990 on a quarterly basis (similar to Figure 18.9). For the output gap, use the percent deviations of real GDP (FRED code: GDPC1) from potential output (FRED code: GDPPOT). For inflation, use the percent change from a year ago of the price index for personal consumption
Inflation is expected to rise when the Taylor Rule persistently and significantly exceeds the federal funds rate. Conversely, inflation is expected to decline when the federal funds rate exceeds the rule. Using the same indicators as in Data Exploration Problem 1, plot since 1965 on a quarterly
Assess the impact of targeted asset purchases by plotting since 2003 on a monthly basis the Federal Reserve’s holdings of mortgage-backed securities (FRED code: MBST) and (on the right scale) the average yield on 30-year fixed-rate mortgages (FRED code: MORTGAGE30US). Discuss how these purchases
In 2002, the Federal Reserve began to set the discount rate above the federal funds rate, reversing its previous practice of keeping the discount rate below the funds rate. To assess the impact, plot on a monthly basis from 1990 to 2007 the difference between the federal funds rate and the
With nominal interest rates at zero, expectations of deflation raise the real interest rate. Japan has faced the zero-bound-deflation problem for many years. Plot since 2000 the nominal interest rate on Japanese Treasury bills (FRED code: INTGSTJPM193N), the inflation rate based on the percent
Explain the mechanics of a speculative attack on the currency of a country with a fixed exchange-rate regime.
Country A frequently experiences large business cycle swings. Under what conditions might it be appropriate for country A to dollarize?
In the first half of 1997, the Bank of Thailand maintained a fixed exchange rate of 26 Thai baht to the U.S. dollar, but Thai interest rates were substantially higher than those in the United States and Japan. Thai bankers were borrowing money in Japan and lending it in Thailand. (a) Why was this
Explain why a central bank is usually more effective at holding the value of its domestic currency at an artificially low level for a sustained period than at an artificially high level.
When asked about the value of the dollar, the Chair of the Federal Reserve Board answers, "The foreign exchange policy of the United States is the responsibility of the Secretary of the Treasury; I have no comment." Discuss this answer.
Explain why a consensus has developed that countries should either allow their exchange rates to float freely or adopt a hard peg as an exchange-rate regime?
Explain the costs and benefits of dollarization. Could a dollarized regime collapse?
Show the impact on the Federal Reserve’s balance sheet of a foreign-exchange market intervention where the Fed sells $1,000 worth of foreign exchange reserves. Explain what impact, if any, the intervention will have on the domestic money supply.
If the Federal Reserve decides to sterilize the foreign-exchange market intervention described in Problem, show the impact on the Fed’s balance sheet. What would the overall impact be on the monetary base? What would be the impact, if any, on the exchange rate? You should assume that the
Use a supply and demand diagram for dollars to show the impact of an increase in U.S. interest rates relative to interest rates in the euro area in the wake of a foreign-exchange market intervention by the Federal Reserve.
Do you think the U.S. dollar is more likely to strengthen or weaken over the next few months? Explain your reasoning.
China’s stock of foreign-exchange reserves has risen more than 20 times since 2000, and approached $3.5 trillion in the spring of 2013. Do you think that pace of reserve accumulation is likely to continue? Why or why not?
Consider a small open economy with a wide array of trading partners all operating in different currencies. The economy’s business cycles are not well synchronized with any of the world’s largest economies and the policymakers in this country have a well-earned reputation for being fiscally
During the time of the currency board, Argentinean banks offered accounts in both dollars and pesos, but loans were made largely in pesos. Describe the impact on banks of the collapse of the currency board.
Investors became nervous just before the 2002 Brazilian presidential election. As a result, the risk premium on Brazilian government debt increased dramatically and Brazil’s currency depreciated significantly. (a) How could concern over an election drive up the risk premium?(b) How was the risk
Explain why a well-capitalized domestic banking system might be important for the successful maintenance of a fixed exchange-rate regime.
Why might sterilized foreign-exchange market intervention have a greater impact on the exchange rate in times of financial stress than in times of normal market conditions?
You observe that two countries with a fixed exchange rate have current inflation rates that differ from each other. You check the recent historical data and find that inflation differentials have been present for several months and that they have not remained constant. How would you explain these
Assuming the country is open to international capital flows, which of the following combinations of monetary and exchange-rate policies are viable? Explain your reasoning.(a) A domestic interest rate as a policy instrument and a floating exchange rate.(b) A domestic interest rate as a policy
A small eastern European economy asks your opinion about whether they should pursue the path to joining the European Economic and Monetary Union (EMU) or simply “euroize” (i.e. dollarize by using the euro for all domestic transactions). What advice would you give?
Panama, Ecuador, and El Salvador began using the U.S. dollar as their domestic currency in 1904, 2000, and 2001, respectively. How do you expect their inflation rates to compare with U.S. inflation? Plot since 1960 the percent change from a year ago of consumer prices in Panama (FRED code:
Did the September, 2000, currency intervention by the United States and other countries influence the dollar-euro exchange rates? Plot for the September-October 2000 period the daily dollar-euro exchange rate (FRED code: EXUSEU) and, on the right scale, the Fed’s sales of dollars for Euros (FRED
Some claim that adoption of a gold standard would contribute to price stability. Was price stability a feature of the U.S. gold standard that prevailed prior to World War I (see Applying the Concept on page 537)?Based on a plot of the general price level (FRED code: M04051USM324NNBR), discuss U.S.
China is the world’s largest exporter and has a fixed nominal exchange to the U.S. dollar. However, China’s real exchange rate, which determines the country’s competitiveness, can change even when the nominal rate is fixed. Plot since 1993 the nominal exchange rate of Yuan per dollar (FRED
In September 1992, a speculative attack compelled the United Kingdom to devalue the British pound versus the German currency (Deutsche Mark). How did monetary policy in both countries influence this outcome? Plot from 1990 to 1992 the discount rates in the United Kingdom (FRED code: INTDSRGBM193N)
Explain why giving an independent central bank control over the quantity of money in the economy should reduce the occurrences of periods of extremely high inflation, especially in developing economies.
If velocity were predictable but not constant, would a monetary policy that fixed the growth rate of money work?
Describe the impact of financial innovations on the demand for money and velocity.
Suppose that expected inflation rises by 3 percent at the same time that the yields on money and on non-money assets both rise by 3 percent. What will happen to the demand for money? What if expected inflation rose by only 2 percent? What if the yield on non-money assets rose by 4 percent?
Provide arguments both for and against the Federal Reserve’s adoption of a target growth rate for M2. What assumptions would be necessary to compute such a target rate?
Draw a graph of money demand and money supply with the nominal interest rate on the vertical axis and money balances on the horizontal axis. Assume the central bank is following a money growth rule where its sets the growth rate of money supply to zero. Use the graph to illustrate how fluctuations
Using the same graph as that described in Problem, show how the central bank could use its control over the quantity of money to target a particular interest rate in the face of changes in velocity.
Why might targeting the money supply lead to lower output growth than targeting the rate of interest?.
Which of the following factors would increase the transactions demand for money? Explain your choices.(a) Lower nominal interest rates.(b) Rumors that a computer virus had invaded the ATM network.(c) A fall in nominal income.
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