Questions and Answers of Financial System Of The Economy

Assume that the Fed is targeting an interest rate and the demand for money increases. Explain why the money supply will increase.
Assume that the Fed is targeting the money supply and the demand for money falls. Explain why interest rates will fall.
We have stressed that the goals of efficiency and competition may conflict with the goals of safety and soundness. Give an example of when this could occur.
What is meant by a dual banking system?
What is a bank holding company? Why have most large banks become bank holding companies? What is a financial holding company? What must a bank holding company do to become a financial holding company?
What are the two major provisions of the McFadden Act? What was the motivation behind its passage?
What is the IBBEA? What was the motivation behind its passage?
How did multibank holding companies “get around” the McFadden Act before the passage of the IBBEA? Defend the following statement: The IBBEA did nothing more than endorse what was happening in
Critique the following statement: Since there are over 7,100 commercial banks in the United States, banking is obviously a highly competitive industry.
What is liquidity risk? Discuss ways in which banks deal with this risk. Does the development of nondeposit liabilities increase or decrease liquidity risk?
Identify two factors that have contributed to the growth of international banking. What factors contribute to reduced profit margins in this area?
Jessie bought a share of stock for $100. She borrowed $50 from her broker. There is a 25 percent maintenance margin requirement established by the brokerage firm she does business with. The price of
What is a real money balance? If the nominal money supply increases 20 percent while prices increase 20 percent, what happens to the demand for real money balances? What happens to the supply of real
If real income increases 20 percent, what happens to the demand for real money balances? Is the change in demand proportional to the change in real income?
What is the difference between a one-time increase in prices and inflation? How does a onetime increase in prices affect the demand for real money balances? How does expected inflation affect the
Why do firms want to hold real money balances? Why do house holds? What factors determine the quantity of real balances that each wants to hold?
What happens to the demand for real balances if interest rates on time deposits rise relative to interest rates on checkable deposits?
Correct the following statement: “When the interest rate increases, the demand for real money balances decreases.
Changes in money were more highly correlated with changes in nominal GDP than with changes in either real GDP or inflation. Does this finding support or refute monetarism? Explain.
Using the liquidity preference theory, explain why the quantity demanded of money is inversely related to the interest rate. What is a liquidity trap?
When is the market for real money balances in equilibrium? If the Fed engages in open market sales, what happens to the supply of real balances?
Explain the transactions and precautionary motives for demanding real money balances.
What are the benefits of holding real money balances? What are the costs? What is the optimum amount of real money balances that house holds and firms will demand?
Do assets equal liabilities for. (a) An individual house hold? (b) The house hold sector as a whole? (c) The economy as a whole? Explain.
Both changes in income and changes in the interest rate affect spending. Which has a greater effect? Explain.
Explain the effect that each of the following variables has on house hold and/or business spending or saving:(a) Income; (b) Wealth; (c) The interest rate; (d) Capacity utilization; (e)
Define the following terms: depreciation, net investment, and investment spending.
Is money a financial asset?
What are some of the factors that determine whether a firm chooses internal or external financing? How is the leverage ratio related to the borrowing constraint?
Do most college students face a borrowing constraint? Explain.
My income is going up, but interest rates are also higher. Will I buy a new car?
How should the government decide whether to increase or decrease its purchases of goods and services? How does this procedure compare with the political process that is used?
How will a reduction in a government deficit affect aggregate demand? Do changes in transfer payments affect aggregate demand?
How can government expenditures be financed?
Assume a constant supply of loanable funds. When government deficit spending leads to increases in the demand for loanable funds, do interest rates always rise? Explain.
If the economy is at full employment and the government increases its purchases of goods and services, does this always lead to crowding out? Is crowding out good or bad for the economy?
Distinguish between public debt and a deficit.
When the U.S. Treasury issues government securities, who buys those securities?
Will increased government spending always lead to crowding out if the economy is not at full employment? (Consider the case in which the increased spending involves transfer payments rather than the
Discuss the following statement: If the Treasury increases its borrowing today, interest rates will always go up.
Briefly discuss the long-term effects of government borrowing and the public debt.
What is the relationship between net exports and aggregate demand, and between net exports and capital flows? If net exports increase, ceteris paribus, what happens to real GDP? If the domestic price
When the government balance is in surplus, does the government debt still have to be rolled over? Explain.
Why has the government regularized its borrowing?
Assume that Rosemarie and Jack have the following assets at the end of the year:What is the total of their real assets? What is the total of their financial assets? What are their total assets?
What would happen to U.S. interest rates if, ceteris paribus, foreigners decided to sell some of the U.S. financial assets that they own?
Explain the difference between aggregate demand and the aggregate quantity demanded of real output. Ceteris paribus, how is quantity demanded related to the overall price level?
Explain the wealth effect, the substitution-of foreign- goods effect, and the constant nominal income effect.
What are the major sources of changes in aggregate demand? What are the short- run and the long- run effects?
What does investment spending consist of? How is investment spending related to the interest rate? Which is more volatile, consumption or investment? Which makes up a larger component of GDP?
Explain why only government purchases of goods and services, not transfers, are a component of aggregate demand.
What are net exports? How are they related to the exchange rate?
If prices and wages always change by exactly the same percentage and are expected always to do so, how is the short-run aggregate supply curve shaped? Make an argument that in this case, there is no
Can the natural level of real output ever change? If so, when? How is the natural level of real output related to the long- run aggregate supply curve?
How do price expectations affect the position of the short- run aggregate supply curve?
What causes the short- run aggregate supply curve to shift left? Right?
Graphically illustrate the difference between a change in aggregate demand and a change in the aggregate quantity demanded of real GDP. Illustrate an increase in aggregate demand and an increase in
Why is the demand curve for wheat downward sloping? Why is the aggregate demand curve downward sloping? Explain why the reasons are different.
Draw a short-run aggregate supply curve. Why is the curve upward sloping? What causes the short-run aggregate supply curve to shift?
Assume that the economy is originally in longrun equilibrium and that there is a drop in demand. Use graphs to explain how and why the economy initially moves to a short-run equilibrium with
What are the goals of monetary policy?
How are the goals of full employment and stable prices related to the long-run goal of economic growth? How can policy makers affect long-run growth?
Why do policy makers have to be aware of the external balance?
Explain why the short-run goal for inflation is not always zero percent.
What is deflation, and why do policy makers have to be concerned about it?
Does the natural level of unemployment ever change? If it does, explain why.
Explain why the numerical objectives of policy change.
What is a supply shock? What is the appropriate policy response to a negative supply shock? What determines whether policy makers should act or do nothing in the face of adverse shocks to either
In the context of monetary policy, what is accommodation? If the Fed usually increases the money supply in response to decreases in aggregate demand, how will this affect the adjustment process?
Define both cost-push and demand-pull inflation.
How is the natural level of real output related to the natural rate of unemployment?
Can the economy experience a demand-pull inflation and a recession at the same time?
In the late 1990s, Congress and the president eliminated the federal deficit. What effect did this have on aggregate demand?
Can a person be employed but not be in the labor force? Can a person be unemployed but not be in the labor force?
The nominal interest rate is 3 percent, but people expect prices to fall by 4 percent. What is the real interest rate? If the tax rate is 20 percent, what is the real after-tax return?
Draw the long-run aggregate supply curves for successive long-run equilibriums with a potential growth rate of real GDP at 2.5 to 3.0 percent per year. What is the sustainable growth rate of output
Graphically demonstrate the appropriate Fed policy in response to a severe unexpected drop in aggregate demand.
Graphically demonstrate how changes in aggregate demand cause inflation or deflation (falling prices) in the short run. Explain why only the price level changes in the long run. What happens to the
What are the ultimate targets of monetary policy?
What is an intermediate target? Why does the Fed use intermediate targets instead of focusing on the ultimate targets? What is an operating target?
What is the recognition lag? The policy lag? The impact lag?
How would the recognition, policy, and impact lags differ with regard to monetary and fiscal policy? What role does uncertainty play?
Are current incoming economic data or forecasts more important in guiding monetary policy? Why?
What is policy regret? What are some of the strategies that the Fed could use to minimize policy regret?
Why can short-term goals sometimes differ from long-term goals? Why does the Fed now establish long-term economic projections four times a year rather than two times?
What is an irregular variance? How does it affect Fed behavior?
What are some common intermediate targets that the Fed has used to guide policy in recent years? Give two criteria for intermediate targets.
Why can’t the Fed target both an interest rate and a monetary aggregate simultaneously?
The Fed should do everything it can to eliminate inflation.” Do you agree? Explain.
Can using an interest rate as an intermediate target ever have an inflationary bias? Explain.
Assume that the Fed is targeting an interest rate and aggregate demand drops. Show graphically why the Fed will have to reduce the supply of money to maintain the interest rate target.
What should the Trading Desk do if the fed funds rate falls below the targeted rate?
Explain what is meant by the reserve need.
For what purposes are system repurchase agreements and reverse repurchase agreements likely to be used?
For what purposes are outright purchases and sales likely to be used?
What is the computation period? What is the maintenance period?
When and why would the Fed accommodate a rise in reserve demand by supplying more reserves?
What characteristics of Treasury bills make them desirable for use in outright transactions by the Trading Desk?
The float increases unexpectedly. Will the Fed typically respond with outright purchases or temporary purchases?
Why have required reserves fallen in recent years? Will the trend continue?

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