Economics Questions | EssayIvy.com

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Economics Questions

1. “The Federal Reserve System is structured in such a way as to insulate monetary

policy from the political pressures characteristic of the rest of our political system of

representative democracy.” Do you agree or disagree with this quote? Explain your

answer.

I disagree with this quote because FED was mainly designated to stop the increase in

inflation and to help the stock market by controlling the money supply and increasing the dollar

worth by manipulating money supply (Mankiw and Nicholas 653). Therefore, although the FED

is an independent government agency mandated with the determination of the long-run monetary

policy of a nation, it is not entirely excluded from congregational administrative pressures. The

founders determined that political pressures would result in unfavorable financial impacts and

imposed measures in order to minimize the risk. For instance, the chairman and Board of

Governors were to hold office for a predetermined period of time. Additionally, the Federal

Reserve does not receive resources in the entire congressional budget process. Nevertheless,

despite the efforts put I place by FDE, they are still affected by political pressures from the

congress. This, therefore, proves that it is skeptical for FDE to truly keep their autonomy.

2. a) In what sense does the Fed "create money"?

The FED creates money by buying mortgage or treasury securities from the open market

using funds that were previously non-existent. In settling the payment for these securities, FED

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generates reserves that did not previously exist by crediting the bank reserve account

(Landesman and Robert 204). By doing this, they create a chain of new loans and deposits and it

also keeps them from borrowing funds from the Congress.

b) Suppose that the minimum required reserve ratio for banks was 1/11. Also,

suppose that banks held no excess reserves and that currency in circulation was

unchanged. What action in the Treasury bill market would the Fed have to take to increase

bank checking account deposits by $990 million?

In order for Fed to increase the bank checking account deposits, they will be forced to

buy bonds and securities from the open market by utilizing funds that were previously

nonexistent. This means that, in order to increase the checking account deposits by $990 million,

FED will be forced to divide the total checking account deposits of $990million by the money

multiplier which is 11 in this case. This will give $90 million. This means that the value of

securities to be purchased should amount to $90 million

3. Assuming that banks used all their excess reserves to support an increase in the

volume of bank lending, by how much would bank lending expand if the Fed

undertook the policy action that was your answer to question (2)?

In order to increase the volume of bank lending, banks will be forced to keep $90 million

in reserves thereby expanding lending by $900 million. This is determined by subtracting the

number of reserves to be purchased ($90) from the bank checking account deposits ($990).

5. Suppose that households in the US switched some of their wealth out of their

checking accounts and into short term bank CD's. If banks use all excess reserves to

support increased lending, what is the effect on this household behavior on the

overall volume of bank lending? What is its effect on the level of M1?

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If banks use their surplus reserves to satisfy increased lending, the household behavior

will likely to be affected and banks will be forced to increase their short term lending capacity.

This depicts that money will be transferred from accounts that are easily accessible to those that

account holders cannot access. Therefore, the bank will hold the money CDs as surplus reserves

thus increasing its lending power. The MI, which is the amount of money in circulation and the

amount of checking account deposits will reduce given that the bank checking account deposits

will decrease.

6. What is the difference between the Federal Reserve’s “discount rate” and the

“federal funds” rate? Why is the discount rate in the US not as important in

financial markets as the federal fund's rate?

The discount rate refers to the rate charged to depository institutions as well as

commercial banks on loans that they borrow from FED (Thomas and Lloyd 209). The federal

fund's rate, on the other hand, refers to the rate that banks charge each other for loans. The

federal fund's rate is also referred to as overnight lending rate. The central bank encourages

banks to borrow from the open market over Fed without affecting individuals by increasing the

discount rate. The discount rate is normally set higher than that which is charged by Fed in the

federal funds market. This rate discourages banks from borrowing. Therefore, banks often opt to

borrow funds from each other at rates that are lower than that charged by Fed.

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Works Cited

Landesman, Robert E. Rx America. Place of publication not identified: Lulu Com, 2011. Print.

Mankiw, Nicholas G. Principles of Economics. Mason, Ohio: Thomson/South-Western, 2007.

Print.

Thomas, Lloyd B. Money, Banking, and Financial Markets. Mason (OH: South-Western, 2006.

Print.

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