Question

A. The interest rate that the Fed pays on reserves acts as a ceiling on the federal funds rate. True False

B. Suppose that the Fed undertakes an open market sale, selling $1 million worth of securities to a bank.  If the required reserve ratio is 8%, checkable deposits (or the money supply), would _______________ by ________________ million, assuming that there are no cash leakages and that banks hold zero excess reserves.

rise; $12.5

decline; $8

decline; $12.5

rise; $8

C. Although the Fed can destroy money, it is impossible for the Fed to create money out of thin air.

True

False

D. If the Fed lowers the discount rate (relative to the federal funds rate), banks will (likely) borrow __________ from the Fed, which will __________ reserves in the banking system, and eventually __________ the money supply.

less; decrease; lower

more; increase; raise

the same amount; not change; lower

more; decrease; raise

none of the above

Answer 1

A) False

Federal funds rate is the interest rate at which banks lend money to other banks for overnight.

B) decline; $12.5

Sale of government securities decreases supply of money in the economy.

Decrease in money supply = $ 1 million x 1/Required reserve = 1 million x 1/0.08 = 1 million x 12.5 = 12.5 million

C) False

Fed can increase supply of money by printing more money.

D) more; increase; raise

Less discount rate encourage banks to borrow more which increases their reserves and thus lending. This results in increase in money supply.