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FSU ECO 3223 - STUDY GUIDE FOR EXAM #3

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ECO 3223 – SP 2012 EVANSSTUDY GUIDE FOR EXAM #3Note: This is intended to direct you to the relevant topics that will be covered on theexam. Questions will be worded differently, so don’t MEMORIZE this content; use it tohelp you understand the concepts. CHAPTER 14* Know all of the Key Terms from this chapter.Borrowed reserves: a bank’s borrowings from the Fed.Discount Rate: The interest rate that the Federal Reserve charges banks on discount loans.Excess Reserves: Reserves in excess of required reserves.Float: Cash items in process of collection at the Fed minus deferred-availability cash items.High-powered money: the monetary base.Monetary Base: The sum of the Fed’s monetary liabilities (currency in circulation and reserves) and the U.S. Treasury’s monetary liabilities (Treasury currency in circulation, primarily coins).Money Multiplier: A ratio that relates the change in the money supply to a given change in the monetary base.Multiple deposit creation: The process whereby, when the Fed supplies the banking system with $1 of additional reserves, deposits increase by a multiple of this amount.Non-borrowed monetary base: the monetary base minus discount loans (borrowed reserves).Open market operations: The Fed’s buying or selling of bonds in the open market.Open market purchase: A purchase of bonds by the Fed.Open market sale: A sale of bonds by the Fed.Required reserve ratio: The fraction of deposits that the Fed requires be kept as reserves.Required reserves: Reserves that re held to meet the Fed’s requirement that for every dollar of deposits at a bank, a certain fraction must be kept as reserves.Reserves: Banks’ holding of deposits in accounts with the Fed plus currency that is physically held by banks (Vault Cash)Simple deposit multiplier: The multiple increase in deposits generated from an increase in the banking system’s reserves in a simple model in which the behavior of depositors and banks playsno role.1. Who are the four “players” in the money supply process?The four players in the money supply process are the central bank, banks, depositors, and borrowers. (pg.345, class discussion)12. The Fed’s Balance Sheet: How does the Fed use changes in its balance sheet to conduct monetary policy?For expansionary monetary policy the government engages open market purchase, in which the Fed purchases bonds from a bank and thus when the bank raises its reserves it raises reserves in the Fed as well adding to more liabilities, but in the process pumping more money into the money supply through deposit creation, expanding the economy. Open market sale works the same. Through the assets side it controls the discount loan and thus set the interest rate at which they lend to banks, which could affect monetary policy whether banks are willing to borrow more due to low interest rates or borrow less if interest rates go up. (pgs. 346-352)3. What is the monetary base? Why is it referred to as “high-powered money”?The monetary base is the currency in circulation plus the total reserves in banking system.Referred to as MB= C + R. It is called high-powered money because an increase in the monetary base can create a stronger increase in the money supply through the money multiplier. (pg. 347)4. What is the effect on the monetary base of an Open Market Purchase? Open Market Sale?Open Market Purchase increases the monetary base because the Fed is using cash to pay for bonds they buy, and thus that money gets deposited by banks to the Fed as reserves increasing the monetary base. An Open market sale decreases the monetary base because the government sells bonds and thus when it receives the money as payment that money has been taking out of circulation lowering C, and thus decreasing the monetary base. (pg. 348-351)5. If the seller of bonds to the Fed keeps the proceeds in currency, what will be the effect on the monetary base? On reserves? On deposit expansion? The monetary base will increase because there is an increase in the currency in circulation. However it will not have any effect on reserves because are not receiving that money to increaser their reserves. As a result there is no deposit expansion because the seller is not depositing that money in the banks.(pg. 350)6. What effect do Discount Loans have on the monetary base?Discount loans increase the monetary base by giving money to the banks and thus increasing their reserves, the increase in reserves increases the monetary base. (pg. 352)7. Does the Fed have complete control over the composition of the monetary base (currency portion, required reserves portion, excess reserves portion)? Why or why not?The Fed does not have control over the currency portion because it cannot determine what the holder of the currency is going to do with it, he could spend it or deposit it. Through this reason the Fed does not have complete control of excess reserves because it means that people could deposit or not deposit. In addition it cannot force banks to hold excess reserves beyond the required reserves. This shows that required reserves is the only component Fed has complete control over. (pg. 360-361)8. What determines the quantity of new loans a bank is able to make? What deteremines the quantity of new loans a bank is able to make depends upon the required reserve ratio, and whether or not the bank feels there is going to be a rush of deposit outflows and thus hold more excess reserves instead of lending out. (pg. 359)29. The simple deposit multiplier assumes that the Fed has complete control over the expansion of the monetary base. Is this an accurate assumption? Why or why not?No it is not an accurate assumption because the Fed does not have complete control over the expansion of the monetary base because even though it can set a discount rate it does not mean that banks are going to automatically borrow from the Fed. In addition they don’t know what the sellers of bonds are going to do with the money they receive. Thus these uncertainties do not allow the Fed to have complete control, but they still have some control. (pg. 353)10. What is the money multiplier “m”, and how is it different from the simple deposit multiplier?The money multiplier tells us how much the money supply changes for a given change in the monetary base. Its different than the simple deposit multiplier because it takes into account things the Fed cannot control such as the excess reserves and the currency in


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