Content check — Economics, Chapter 28: Monetary Policy and Bank Regulation

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Chapter 28: Monetary Policy and Bank Regulation

9 problems · 0 figures

Why is it important for the members of the Board of Governors of the Federal Reserve to have longer terms in office than elected officials, like the President?

Answer

Longer terms insulate the Board from political forces. Since the presidency can potentially change every four years, the Federal Reserve’s independence prevents drastic swings in monetary policy with every new administration and allows policy decisions to be made only on economic grounds.

28-2 §28.2 source ↗

Given the danger of bank runs, why do banks not keep the majority of deposits on hand to meet the demands of depositors?

Answer

Banks make their money from issuing loans and charging interest. The more money that is stored in the bank’s vault, the less is available for lending and the less money the bank stands to make.

28-3 §28.2 source ↗

Bank runs are often described as “self-fulfilling prophecies.” Why is this phrase appropriate to bank runs?

Answer

The fear and uncertainty created by the suggestion that a bank might fail can lead depositors to withdraw their money. If many depositors do this at the same time, the bank may not be able to meet their demands and will, indeed, fail.

28-4 §28.3 source ↗

If the central bank sells $500 in bonds to a bank that has issued $10,000 in loans and is exactly meeting the reserve requirement of 10%, what will happen to the amount of loans and to the money supply in general?

Answer

The bank has to hold $1,000 in reserves, so when it buys the $500 in bonds, it will have to reduce its loans by $500 to make up the difference. The money supply decreases by the same amount.

28-5 §28.3 source ↗

What would be the effect of increasing the banks' reserve requirements on the money supply?

Answer

An increase in reserve requirements would reduce the supply of money, since more money would be held in banks rather than circulating in the economy.

28-6 §28.4 source ↗

Why does contractionary monetary policy cause interest rates to rise?

Answer

Contractionary policy reduces the amount of loanable funds in the economy. As with all goods, greater scarcity leads a greater price, so the interest rate, or the price of borrowing money, rises.

28-7 §28.4 source ↗

Why does expansionary monetary policy causes interest rates to drop?

Answer

An increase in the amount of available loanable funds means that there are more people who want to lend. They, therefore, bid the price of borrowing (the interest rate) down.

28-8 §28.5 source ↗

Why might banks want to hold excess reserves in time of recession?

Answer

In times of economic uncertainty, banks may worry that borrowers will lose the ability to repay their loans. They may also fear that a panic is more likely and they will need the excess reserves to meet their obligations.

28-9 §28.5 source ↗

Why might the velocity of money change unexpectedly?

Answer

If consumer optimism changes, spending can speed up or slow down. This could also happen in a case where consumers need to buy a large number of items quickly, such as in a situation of national emergency.

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Problems and answers are adapted from Principles of Economics 3e by Steven A. Greenlaw, David Shapiro and Daniel MacDonald, OpenStax, and are used under the CC BY-NC-SA 4.0 licence. Access for free at https://openstax.org/books/principles-economics-3e/pages/1-introduction. Illustrations: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license. This adaptation is released under the same licence, is non-commercial, and is neither affiliated with nor endorsed by OpenStax or Rice University.