Money Banking And Financial Markets 3rd Custom Edition Stephen G Cecchetti ,Kermit L Schoenholtz - Solutions

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Compare the impact of a given change in monetary policy in two economies that are similar in every way except that, in Economy A, the financial system is very evolved with a large shadow banking system providing many alternatives to bank financing, while in Economy B, bank loans account for almost
Use the aggregate demand-aggregate supply framework to show how a boom in equity prices might affect inflation and output in the short run. In the absence of any policy change by the central bank, what would the long-run impact be on inflation and output?
Suppose the policy interest rate controlled by the central bank and the inflation rate were both zero. Explain in terms of the aggregate demand-aggregate supply framework how the economy could fall into a deflationary spiral if it were hit by a negative aggregate demand shock.
Suppose there is an unexpected slowdown in the rate of productivity growth in the economy so that forecasters consistently overestimate the growth rate of GDP. If the central bank bases its policy decisions on the consensus forecast, what would be the likely consequences for inflation assuming it
In the wake of the financial crisis of 2007-2009, would you anticipate the bank- lending channel becoming more or less important in the United States in the near future? Explain your answer.
Do you think the balance-sheet channel of monetary policy would be stronger or weaker ifa. Firms' balance sheets in general are very healthy?b. Firms have a lot of existing variable-rate debt?
Consider a situation where central bank officials repeatedly express concern that output exceeds potential output and that the economy is overheating. Although they haven't implemented any policy moves as yet, the data show that consump- tion of luxury goods has begun to slow. Explain how this
Suppose in Country A, changes in short-term interest rates translate quickly into changes in long-term interest rates, while in Country B long-term inter- est rates do not respond much to changes in short-term rates. In which country would you expect the interest-rate channel of monetary policy to
For each of the following, explain whether the response is theoretically consis tent with a tightening of monetary policy and identify which of the traditional channels of monetary policy is at work:a. Firms become more likely to undertake investment projects.b. Households become less likely to
Considering the role of the U.S. house price bubble in the financial crisis of 2007-2009, how do you think monetary policymakers should respond to bubbles in asset markets?
Why might the zero nominal-interest-rate bound lead policymakers to raise their inflation objective?
Many economists have argued that Japan's economic problems during the 1990s were caused largely by bank failures and the refusal of the Japanese government to clean up the banking system. Explain how a collapse of the banking system could cause a fall in real output. Can monetary policymakers do
Describe the theory of the exchange-rate channel of the monetary transmission mechanism. How, through the exchange rate, does an interest rate increase in- fluence output? Why is this link difficult to find in practice?
New developments in information technology have simplified the assessment of individual borrowers' creditworthiness. What are the likely consequences for the structure of the financial system? For monetary policy?
The government decides to place limits on the interest rates banks can pay their depositors. Seeing that alternative investments pay higher interest rates, deposi- tors withdraw their funds from banks and place them in bonds. Will their action have an impact on the economy? If so, how?
During the financial crisis of 2007-2009, the Federal Reserve took many extraordinary measures to support the economy. As the economy recovers, what actions might the Fed take to tighten financial conditions?
When monetary policymakers hit the zero nominal-interest-rate bound with their policy rate, they have the option to turn to unconventional tools of monetary policy. How do these unconventional tools work, and why are policymakers reluctant to use them except in very difficult circumstances?
Explain why monetary policymakers’ actions in cutting the Federal Funds rate to almost zero were not sufficient to boost economic activity during the recession of 2007-2009.
Explain why the traditional interest-rate channel of monetary policy transmission from monetary policy actions to changes in investment and consumption decisions may be relatively weak.
Explain why you might expect the recovery from the 2007-2009 recession to be weaker than normal?
Explain in detail how monetary policy influences banks’ lending behavior. Show how an open market purchase affects the banking system’s balance sheet, and discuss the impact on the supply of bank loans. (You may wish to refer to Chapter 17 in answering this question.)w 7 ~ ~~ 7) = 1S] ‘S) ®
Monetary policymakers face significant challenges. To be successful, they requirea. Accurate estimates of potential GDP, even when its growth trend is shifting.b. An understanding of how to cope with the problems created by the zero nominal-interest-rate bound and the possibility of deflation.c. A
Monetary policy influences the economy through several channels.a. The traditional channels of monetary policy transmission are interest rates and exchange rates.i. Interest rates influence consumption and investment.ii. Exchange rates affect net exports.b. Monetary policy affects the supply of
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 growth rate
Use the following Taylor rule to calculate what would happen to the real interest rate if inflation increased by 3 percentage points.
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
Using a graph for overnight interbank loans in Europe, show how, in early 2010, the overnight interbank rate could not have not fallen more than 75 basis points below the minimum bid rate regardless of how much demand for reserves fell.
Suppose the Federal Reserve did not pay interest on excess reserves. How would the reserve demand curve differ from that in Figure 18.2?
Consider a situation where reserve requirements were binding and the Federal Reserve decided to reduce the requirements. Use the graph of the Market for Bank Reserves to illustrate how the Open Market Trading Desk would react to this change assuming the demand for excess reserves remains unchanged.
Suppose, one morning, the Open Market Trading Desk drastically underesti- mates the demand for reserves when deciding the quantity of reserves to supply to the market. Use the graph of the Market for Bank Reserves to show why the market federal funds rate will not exceed the discount rate
Suppose the demand for reserves is stable. Use a graph of the Market for Bank Reserves to show how the Open Market Trading Desk would implement a deci- sion by the FOMC to raise the target federal funds rate. You should assume that the discount and deposit rates are adjusted so that the spreads
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
How might the Federal Reserve exit from the unconventional policies it em- ployed during the financial crisis of 2007-2009 without causing inflationary problems?
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.
Explain why both the Federal Reserve and the ECB use an overnight interest rate rather than a longer-term interest rate as their policy tool.
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.
The European Central Bank's Web site contains information on the interest rates under the bank's control. At what levels are the interest rates now and when did they last change? At the press conference held at the time of the last change, how did the Governing Council justify the action?
Use your knowledge of the problems associated with asymmetric information to explain why, prior to the change in the Federal Reserve's discount lending facil- ity in 2002, banks were extremely unlikely to borrow from the facility despite funds being available at a rate below the target federal
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
The Web site of the Federal Reserve Bank of New York contains information on the target federal funds rate. Find the data and describe the changes that have occurred since June 2006. Comparing recent developments with earlier patterns in the target, what strikes you as unusual?
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
Suppose the demand for reserves became less stable. How would monetary policy be affected!
Explain how the Federal Reserve limits deviations of the market federal funds rate from its target through use of the "corridor" system.
Unconventional monetary policy is unpredictable and potentially disruptive, so it is used only in those extraordinary circumstances when the conventional toolkit is insufficient to stabilize the economy. One conventional policy tool-the payment of interest on reserves can help a central bank exit
Unconventional monetary policy can supplement conventional policy when a zero policy rate is not low enough to stabilize the economy or when an impaired fi- nancial system prevents conventional interest-rate policy from working. The three principal unconventional tools of the central bank are:a.
The Taylor rule is a simple equation that describes movements in the federal funds target rate. It suggests thata. When inflation rises, the FOMC raises the target interest rate by 1 times the increase.b. When output rises above potential by 1 percent, the FOMC raises the target interest rate half
Monetary policymakers use several tools to meet their objectives.a. The best tools are observable, controllable, and tightly linked to objectives.b. Short-term interest rates are the primary tools for monetary policymaking.c. Modern central banks do not use intermediate targets like money growth.
The European Central Bank’s primary objective is price stability.a. The ECB provides liquidity to the banking system through weekly auctions called refinancing operations.
The Federal Reserve has four conventional monetary policy tools.a. The target federal funds rate is the primary instrument of monetary policy.i. Open market operations are used to control the federal funds rate.ii. The Fed forecasts the demand for reserves each day and then supplies the amount
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.
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?
Why do you think the statement released after each Federal Open Market Com- mittee meeting retains the same basic structure?
If members of the ECB's Governing Council do decide to take formal votes on monetary policy decisions, do you think these votes should be published? Why or why not?
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?
In February 2009, the Federal Reserve released for the first time a long-run fore- cast for inflation. Do you think this move will help the Federal Reserve control inflation? Do: you think it is equivalent to announcing a formal inflation target?
If you were charged with redrawing the boundaries of the Federal Reserve dis- tricts, what criteria would you use to complete the task?
Currently, all the national central banks in the Eurosystem are involved with the implementation of monetary policy. What do you think the advantage would be of centralizing the conduct of these day-to-day interactions with financial mar- kets at the ECB in Frankfurt? Are there any disadvantages
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.
The Monetary Policy Committee (MPC) of the Bank of England is responsible for setting interest rates in the United Kingdom. Go to the bank's Web site at http://www.bankofengland.co.uk, and get as much information about the MPC as you can. How big is it? Who are its members? How often does it meet?
Why did the "no-bailout" clause of the Maastricht Treaty come under stress dur- ing and after the financial crisis of 2007-2009?
What are the two most important factors in ensuring that power is decentralized in the Eurosystem?
Do you think the FOMC has an easier or a harder time agreeing on monetary policy than the Governing Council of the ECB? Why?
Go to the ECB's Web site and locate the most recent introductory statement made by the president of the ECB at the press conference following a Governing Council meeting. What was the Governing Council's policy decision? How was it justified? Is there any reference to financial stability measures?
What are the goals of the ECB? How are its officials held accountable for meet- ing them?
While the chair of the Federal Reserve Board has only one of 12 votes on the FOMC, he is never in the minority. What gives him the power to control the committee?
How did the political climate in the early 1900s influence the structure of the Federal Reserve System?
How might the financial crisis of 2007-2009 lead to a change in the appoint- ment process of presidents of the regional Federal Reserve banks?
Some people have argued that the high inflation of the late 1970s was a conse- quence of the fact that Federal Reserve Board Chairman Arthur Burns did what President Richard Nixon wanted him to do. Explain the connection.
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 regard- ing the Federal funds target and the two goals of price stability and sustain- able economic growth? Does the statement make any reference to the
What are the Federal Reserve's goals? How are Fed officials held accountable for meeting them?
The European Central Bank (ECB) is the central bank for the countries that participate in the European Monetary Union.a. The ECB is composed of three distinct parts:i. The National Central Banks (NCBs) provide services to the banks and governments in their countries.ii. The European Central Bank in
The FOMC’s success in meeting its objectives is enhanced bya. Its independence, which comes from its members’ long terms, budgetary autonomy, and the irreversibility of its policy decisions.b. Clear communication of its policy decisions through an explanatory statement that is distributed
The Federal Reserve System is the central bank of the United States. Its decentralized structure comprises three primary elements:a. Twelve Federal Reserve Banks, each with its own board of directors, that i. Serve as the government’s bank, issuing currency, maintaining the U.S.Treasury’s bank
Suppose the government is heavily in debt. Why might it be tempting for the fiscal policymakers to sell additional bonds to the central bank in a move that it knows would be inflationary?
Assuming that they could, which of the following governments do you think would be more likely to pursue policies that would seriously hinder the central bank's pursuit of low and stable inflation? Explain your choice.a. A government that is considered highly creditworthy both at home and abroad in
Suppose in an election year, the economy started to slow down. At the same time, clear signs of inflationary pressures were apparent. How might the central bank with a primary goal of price stability react? How might members of the incumbent political party who are up for re-election react?
Provide arguments for why you think the financial crisis of 2007-2009 did or did not compromise the independence of the Federal Reserve.
The long list of central bank goals includes the stability of interest rates and exchange rates. You look on the central bank Web site and note that they have increased interest rates at every one of their meetings over the last year. You read the financial press and see references to how the
"A central bank should remain vague about the relative importance it places on its various objectives. That way, it has the freedom to choose which objective to follow at any point in time." Assess this statement in light of what you know about good central bank design.
Suppose the president of a newly independent country asks you for advice in designing the country's new central bank. For each of the following design features, choose which one you would recommend and briefly explain your choice:a. Central bank policy decisions that are irreversible or central
Suppose the central bank in your country has price stability as its primary goal. Faced with a choice of having monetary policy decisions made by a well- qualified individual with an extremely strong dislike of inflation or a committee of equally well-qualified people with a wide range of views,
Which do you think would be more harmful to the economy-an inflation rate that averages 5 percent a year and has a high standard deviation or an inflation rate of 7 percent that has a standard deviation close to zero?
Since 1993, the Bank of England has published a quarterly Inflation Report. Find a copy of the report on the bank's Web site, http://www.bankofengland.co.uk. Describe its contents, and explain why the bank might publish such a document.
While central bank transparency is widely accepted as desirable, too much open- ness may have disadvantages. Discuss what some of these drawbacks might be.
In what way did the financial crisis of 2007-2009 emphasize the importance of central bank transparency?
Explain how transparency helps eliminate the problems that are created by cen- tral bank independence.
Explain why even the most independent central banks are still dependent on the support of the government to meet their policy objectives effectively?
The Maastricht Treaty, which established the European Central Bank, states that the governments of the countries in the European Monetary Union must not seek to influence the members of the central bank's decision-making bodies. Why is freedom from political influence crucial to the ECB's ability
Suggest one way in which the Federal Reserve contributed to the financial crisis of 2007-2009 and one way in which it helped contain the crisis.
Provide arguments for and against the proposition that a central bank should be allowed to set its own objectives.
Explain the costs of each of the following conditions and explain who bears them.a. Interest-rate instabilityb. Exchange-rate instabilityc. Inflationd. Unstable growth
The power of a central bank is based on its monopoly over the issuance of cur- rency. Economics teaches us that monopolies are bad and competition is good. Would competition among several central banks be better? Provide arguments both for and against.
In 1900, there were 18 central banks in the world; 100 years later, there were 174.Why does nearly every country in the world now have a central bank?
Fiscal policy can make the central bank’s job impossible because a.b.Politicians tend to take a short-term view, ignoring the inflationary impact of their actions over the long term.Politicians are predisposed toward financing techniques that will create inflation.Inflation provides immediate
The best central banks So aSer Are independent of political pressure.Make decisions by committee rather than by an individual.Are accountable to elected representatives and the public.Communicate their objectives, actions, and policy deliberations clearly to the public.Articulate clearly how they
The objective of a central bank is to reduce systematic risk in the economic and financial system. Specific objectives include. Low and stable inflation.b. High and stable growth and employment.c. Stable financial markets and institutions.d efev). Stable interest rates.. Stable exchange rates.
The functions of a modern central bank are toa. Adjust interest rates and other tools to control the quantity of money and credit in the economy.b. Operate a payments system.c. Lend to sound banks during times of stress.d. Oversee the financial system.
You are a bank examiner and have concerns that the bank you are examining may have a solvency problem. On examining the bank's assets, you notice that the loan sizes of a significant portion of the bank's loans are increasing in rela- tively small increments each month. What do you think might be
You are the lender of last resort and an institution approaches you for a loan. You assess that the institution has $800 million in assets, mostly in long-term loans, and $600 million in liabilities. The institution is experiencing unusually high withdrawal rates on its demand deposits and is
Regulators have traditionally required banks to maintain capital-asset ratios of a certain level to ensure adequate net worth based on the size and composition of the bank's assets on its balance sheet. Why might such capital adequacy require- ments not be effective?

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