How many members sit on the Federal Reserve's Board of Governors?
Seven
✓
Twelve
Five
Nine
Correct Answer
Seven
The Board of Governors has seven members, each appointed by the President and confirmed by the Senate. Twelve is the number of regional Federal Reserve banks, not governors. Five is the number of regional bank presidents who vote on the Federal Open Market Committee at any one time. Nine is the size of the Supreme Court, not the Fed's board.
Category: Federal Reserve Structure
Question 2
How long is the full term of a member of the Fed's Board of Governors?
4 years
14 years
✓
10 years
7 years
Correct Answer
14 years
Governors serve 14-year terms, and the long, staggered terms help insulate them from short-term political pressure. Four years is the length of the Chair's term as chair, not a governor's full term. Ten years and 7 years are not the length of a governor's term; 7 is the number of governors.
Category: Federal Reserve Structure
Question 3
Which body makes the Fed's decisions about buying and selling government bonds?
Federal Deposit Insurance Corporation
Office of the Comptroller of the Currency
Federal Open Market Committee
✓
National Credit Union Administration
Correct Answer
Federal Open Market Committee
The Federal Open Market Committee (FOMC) decides on open market operations; it is made up of the seven governors plus five regional Fed bank presidents. The Federal Deposit Insurance Corporation insures deposits and examines banks. The Office of the Comptroller of the Currency, part of the Treasury, supervises national banks. The National Credit Union Administration supervises credit unions.
Category: Open Market Operations
Question 4
When the Fed buys Treasury bonds from banks, what happens to bank reserves and the money supply?
Reserves fall and the money supply decreases
Reserves rise and the money supply decreases
Reserves fall and the money supply increases
Reserves rise and the money supply increases
✓
Correct Answer
Reserves rise and the money supply increases
When the Fed buys bonds, it pays banks by adding to their reserves; banks lend out the extra reserves and the money multiplier expands the money supply. Reserves fall and the money supply decreases describes an open market sale of bonds. Reserves rise and the money supply decreases mixes the two directions, since new reserves support more lending. Reserves fall and the money supply increases is also inconsistent, because fewer reserves leave banks less to lend.
Category: Open Market Operations
Question 5
According to the AD/AS model, what does contractionary monetary policy do?
Raises interest rates and shifts aggregate demand left
✓
Lowers interest rates and shifts aggregate demand right
Raises interest rates and shifts aggregate supply right
Lowers interest rates and shifts aggregate supply left
Correct Answer
Raises interest rates and shifts aggregate demand left
Contractionary (tight) policy reduces the supply of loanable funds, which raises interest rates, discourages investment and big-ticket consumer borrowing, and shifts aggregate demand to the left. Lowers interest rates and shifts aggregate demand right describes expansionary policy. Raises interest rates and shifts aggregate supply right is wrong because monetary policy works through aggregate demand. Lowers interest rates and shifts aggregate supply left gets both the rate direction and the curve wrong.
Category: Policy and Economic Outcomes
Question 6
What is the discount rate?
The interest rate banks charge each other for overnight loans
The interest rate the Fed charges banks that borrow from it
✓
The interest rate the Fed pays on balances banks hold with it
The interest rate banks charge their most creditworthy borrowers
Correct Answer
The interest rate the Fed charges banks that borrow from it
The discount rate is what the Fed charges when a bank borrows directly from it through the discount window. The interest rate banks charge each other for overnight loans is the federal funds rate. The interest rate the Fed pays on balances banks hold with it is interest on reserve balances. The interest rate banks charge their most creditworthy borrowers is the prime rate.
Category: Other Policy Tools
Question 7
In a limited-reserves system, what does the model predict if the Fed raises the reserve requirement?
Banks can lend more and the money supply grows
Banks can lend less and the money supply grows
Banks can lend less and the money supply shrinks
✓
Banks can lend more and the money supply shrinks
Correct Answer
Banks can lend less and the money supply shrinks
A higher reserve requirement forces banks to hold a larger share of deposits in reserve, leaving less to lend, so the money supply contracts. Banks can lend more and the money supply grows describes a lower reserve requirement. Banks can lend less and the money supply grows is inconsistent, because less lending means fewer new deposits. Banks can lend more and the money supply shrinks is inconsistent for the same reason in reverse.
Category: Other Policy Tools
Question 8
A bank has $500 million in assets and $450 million in liabilities. What is its net worth?
$950 million
-$50 million
$450 million
$50 million
✓
Correct Answer
$50 million
Net worth, or bank capital, equals assets minus liabilities: $500 million - $450 million = $50 million. $950 million comes from adding the two amounts instead of subtracting. -$50 million reverses the subtraction. $450 million is just the liabilities.
Category: Bank Regulation
Question 9
What does deposit insurance guarantee?
Depositors will not lose insured deposits if their bank fails
✓
Banks will earn a profit on every loan they make
The Fed will buy any bond that a bank wishes to sell
Borrowers need not repay loans from a failed bank
Correct Answer
Depositors will not lose insured deposits if their bank fails
Deposit insurance, run in the United States by the FDIC, protects depositors up to a set limit if their bank fails, which removes the reason for bank runs at insured banks. Banks will earn a profit on every loan they make is false, since loans can default. The Fed will buy any bond that a bank wishes to sell is not part of deposit insurance. Borrowers need not repay loans from a failed bank is false; loans remain owed when a bank fails.
Category: Bank Regulation
Question 10
What is the term for a central bank's role in lending to financial institutions that cannot borrow anywhere else during a crisis?
Fiscal agent
Lender of last resort
✓
Currency board
Deposit insurer
Correct Answer
Lender of last resort
As lender of last resort, the central bank makes emergency loans so that a panic does not bring down solvent institutions, as the Fed did after the 1987 stock market crash. A fiscal agent handles payments and accounts for a government. A currency board is an alternative to a central bank that ties a currency to another currency. A deposit insurer, such as the FDIC, guarantees deposits rather than lending to banks.
Category: Bank Regulation
Question 11
Nominal GDP is $20 trillion and the money supply is $4 trillion. What is the velocity of money?
0.2
80
5
✓
24
Correct Answer
5
Velocity equals nominal GDP divided by the money supply: $20 trillion / $4 trillion = 5, so the average dollar is spent five times a year. 0.2 comes from dividing the money supply by nominal GDP, which is upside down. 80 comes from multiplying the two figures. 24 comes from adding them.
Category: Quantity Equation
Question 12
In the quantity equation MV = PQ, suppose M is 500, V is 4, and real GDP (Q) is 20. What is the price level (P)?
25
125
40,000
100
✓
Correct Answer
100
MV = 500 x 4 = 2,000, and P = 2,000 / 20 = 100. 25 comes from dividing M by Q and ignoring velocity. 125 comes from dividing M by V. 40,000 comes from multiplying all three numbers together.
Category: Quantity Equation
Question 13
A loan carries a nominal interest rate of 4 percent while prices fall by 2 percent per year. What is the real interest rate?
6 percent
✓
2 percent
8 percent
-2 percent
Correct Answer
6 percent
The real interest rate equals the nominal rate minus the inflation rate, and deflation of 2 percent is an inflation rate of -2 percent: 4 - (-2) = 6 percent. 2 percent comes from subtracting the deflation as if it were positive inflation. 8 percent comes from multiplying the two rates. -2 percent is just the inflation rate itself.
Category: Monetary Policy Pitfalls
Question 14
During a recession with output below potential GDP, which policy does a countercyclical approach call for?
Contractionary monetary policy that raises interest rates
Expansionary monetary policy that lowers interest rates
✓
Contractionary monetary policy that lowers interest rates
Expansionary monetary policy that raises interest rates
Correct Answer
Expansionary monetary policy that lowers interest rates
Countercyclical policy leans against the business cycle, so in a recession the central bank uses expansionary policy that lowers interest rates and shifts aggregate demand right toward potential GDP. Contractionary monetary policy that raises interest rates is the response to inflationary pressure, not a recession. Contractionary monetary policy that lowers interest rates is a contradiction, since contractionary policy raises rates. Expansionary monetary policy that raises interest rates is also a contradiction.
Category: Policy and Economic Outcomes
Question 15
Why do long and variable lags make monetary policy difficult to conduct?
Banks are legally barred from responding to interest rate changes
The Fed can change interest rates only once every four years
A policy may take effect after the economy has already changed course
✓
Congress must approve each change before it takes effect
Correct Answer
A policy may take effect after the economy has already changed course
Monetary policy works through bank lending, investment and borrowing with long and variable lags, often many months and sometimes more than a year, so a stimulus aimed at a recession may arrive after recovery has begun and add to inflation. Banks are legally barred from responding to interest rate changes is false; banks respond freely. The Fed can change interest rates only once every four years is false, since the FOMC meets about every six weeks. Congress must approve each change before it takes effect is false; Fed decisions need no congressional approval.
Category: Monetary Policy Pitfalls
Question 16
What idea does the phrase pushing on a string describe in monetary policy?
Contractionary policy may fail because banks lend out every excess reserve
Raising reserve requirements has no effect on the amount banks lend
Open market sales of bonds create money faster than open market purchases
Expansionary policy may fail if banks hold reserves and borrowers avoid loans
✓
Correct Answer
Expansionary policy may fail if banks hold reserves and borrowers avoid loans
Tight policy reliably pulls demand down, like pulling a string, but loose policy cannot force banks to lend or households and firms to borrow, as Japan saw with near-zero rates and slow growth in the early 2000s. Contractionary policy may fail because banks lend out every excess reserve reverses the idea, since tightening is the side that works reliably. Raising reserve requirements has no effect on the amount banks lend is false, since it reduces what banks can lend. Open market sales of bonds create money faster than open market purchases is backward, because sales drain money.
Category: Monetary Policy Pitfalls
Question 17
What did the Fed's quantitative easing programs involve?
Buying long-term government bonds and mortgage-backed securities
✓
Selling short-term Treasury bills to reduce bank reserves
Raising reserve requirements on large commercial banks
Mailing direct cash grants from the Fed to households
Correct Answer
Buying long-term government bonds and mortgage-backed securities
Quantitative easing, begun in late 2008 when short-term rates were near zero, meant large purchases of long-term Treasury bonds and mortgage-backed securities to push down long-term interest rates and stimulate demand. Selling short-term Treasury bills to reduce bank reserves is contractionary, the opposite. Raising reserve requirements on large commercial banks would also tighten credit. Mailing direct cash grants from the Fed to households is not a Fed tool; spending and transfers are fiscal policy.
Category: Other Policy Tools
Question 18
Which goals does the Federal Reserve's legal mandate require it to pursue?
Low inflation only
Low unemployment and low inflation
✓
A fixed exchange rate only
A balanced federal budget and low inflation
Correct Answer
Low unemployment and low inflation
The Fed's legal mandate calls for maximum employment and stable prices, along with moderate long-term interest rates; the employment and price goals together are often called its dual mandate. Low inflation only leaves out the employment half of that mandate. A fixed exchange rate only is not part of the Fed's mandate. A balanced federal budget and low inflation is wrong because the budget is set by Congress and the President through fiscal policy.
Category: Policy and Economic Outcomes
Question 19
In an ample-reserves system, what does the model predict for the federal funds rate if the FOMC raises the interest rate it pays on reserve balances?
It falls, because banks lend more reserves to each other
It rises, because banks borrow more at the discount window
It rises, because banks keep more funds at the Fed
✓
It stays the same, because the two rates are unrelated
Correct Answer
It rises, because banks keep more funds at the Fed
When interest on reserve balances rises, holding reserves at the Fed becomes more attractive, so banks supply fewer funds to the federal funds market and that rate rises. It falls, because banks lend more reserves to each other describes a cut in the rate paid on reserves. It rises, because banks borrow more at the discount window names the wrong mechanism, since higher rates discourage discount borrowing. It stays the same, because the two rates are unrelated is false; banks arbitrage between them.
Category: Other Policy Tools
Question 20
Before deposit insurance, why could a rumor destroy even a healthy bank?
Banks were required by law to keep all deposits in the stock market
Any rumor about a bank automatically cut its discount rate to zero
The Fed had to close any bank that was named in a rumor
Banks hold only part of their deposits as reserves, so mass withdrawals drain cash
✓
Correct Answer
Banks hold only part of their deposits as reserves, so mass withdrawals drain cash
Because banks lend out most deposits, a rush of withdrawals quickly exhausts their reserves, so depositors who waited could lose everything and even solvent banks could fail in a bank run. Banks were required by law to keep all deposits in the stock market is false; banks are generally barred from stock investments. Any rumor about a bank automatically cut its discount rate to zero has no basis. The Fed had to close any bank that was named in a rumor is false; the Fed's role is to lend to sound banks in a panic.
Category: Bank Regulation