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Chapter 16: Q9. (page 347)
True or False: A liquidity trap occurs when expansionary monetary policy fails to work because an increase in bank reserves by the Fed does not lead to an increase in bank lending.
The given statement is true.
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In the tables that follow, you will find consolidated balance sheets for the commercial banking system and the 12 Federal Reserve Banks. Use columns 1 through 3 to indicate how the balance sheets will read after each transaction a to c is completed. Do not cumulate your answers; that is, analyze each transaction separately, starting in each case from the numbers provided. All accounts are in billions of dollars.
\( | Consolidated Balance Sheet: All commercial banks | |||
1 | 2 | 3 | ||
Assets Reserve Securities Loans | 33 60 60 150 3 | |||
Liabilities and net worth: Checkable deposits Loans from federal reserve banks |
\) | Consolidated Balance Sheet: The 12 Federal Reserve Banks | |||
1 | 2 | 3 | ||
Assets Securities Loans to commercial banks | 60 03 33 | |||
Liabilities and net worth: Reserves of commercial bank | ||||
Treasury deposits Federal reserve notes | 3 27 |
a. A decline in the discount rate prompts commercial banks to borrow an additional \(1 billion from the Federal Reserve Banks. Show the new balance-sheet numbers in column 1 of each table.
b. The Federal Reserve Banks sell \)3 billion in securities to members of the public, who pay for the bonds with checks. Show the new balance-sheet numbers in column 2 of each table.
c. The Federal Reserve Banks buy $2 billion of securities from commercial banks. Show the new balance-sheet numbers in column 3 of each table.
d. Now review each of the previous three transactions, asking yourself these three questions: (1) What change, if any, took place in the money supply as a direct and immediate result of each transaction? (2) What increase or decrease in the commercial banks' reserves took place in each transaction? (3) Assuming a reserve ratio of 20 percent, what change in the money-creating potential of the commercial banking system occurred as a result of each transaction?
Which of the following Fed actions will increase bank lending?
Select one or moreanswers from the choices shown.
a. The Fed raises the discount rate from 5 percent to 6 percent.
b. The Fed raises the reserve ratio from 10 percent to 11 percent.
c. The Fed lowers the discount rate from 4 percent to 2 percent.
d. The Fed sells bonds to commercial banks.
In 2009, the inflation rate reached a negative 0.4 percent while the unemployment rate hit 10 percent. If the target inflation rate was 2 percent and the full-employment rate of unemployment was 5 percent, what value does the Taylor Rule predict for the Fed’s target interest rate back then? Would that rate have been possible given the zero lower bound problem?
a. negative 4.6 percent, not possible.
b. positive 0.4 percent, possible.
c. negative 5.6 percent, not possible.
d. positive 6.4, possible.
Refer to Table 16.2 and assume that the Fed’s reserve ratio is 10 percent and the economy is in a severe recession. Also, suppose that the commercial banks are hoarding all excess reserves (not lending them out) because they fear loan defaults. Finally, suppose that the Fed is highly concerned that the banks will suddenly lend out these excess reserves and possibly contribute to inflation once the economy begins to recover and confidence returns. By how many percentage points does the Fed need to increase the reserve ratio to eliminate one-third of the excess reserves? What is the size of the monetary multiplier before and after the change in the reserve ratio? By how much would banks’ lending potential decline as a result of the increase in the reserve ratio?
(1) Reserve Ratio, % | (2) Checkable Deposits, \( | (3) Actual Reserves, \) | (4) Required Reserves, \( | (5) Excess Reserve, \) (3-4) | (6) Money-Creating Potential of Single Bank, \(=5 | (7) Money-Creating Potential of Banking System, \) |
10 20 25 30 | 20,000 20,000 20,000 20,000 | 5,000 5,000 5,000 5,000 | 2,000 4,000 5,000 6,000 | 3,000 1,000 0 -1,000 | 3,000 1,000 0 -1,000 | 30,000 5,000 0 -3,333 |
Who are the MPC?
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