How You Believe Economic Activity Would Be Affected If We Did Not Have Financial Markets and Institutions

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Middle T-account 60 400

340

Bottom T-account 60 480 (60/.125) liability

420

- What is a “call loan”? How did call loans contribute to economic recessions?

A call loan may be “called in”—declared due and payable—by the lender at any time. Until 1913, call loans were the common form of bank financing for agriculture and business. Also, recall that until 1913 there was no “lender of last resort” to keep banks liquid. If too many depositors demanded their money back at once, banks would be forced to call in loans, usually causing borrowers to default, often causing their farms or businesses to fail, and not necessarily raising enough cash to pay off the depositors. The ensuing economic slowdown and financial uncertainty would provoke more depositors to try to withdraw funds from banks, forcing more banks to call in loans, triggering more defaults and business failures, dragging the economy into recession.

청구에 의하여 대출자금을 회수할 수 있는 전형적인 단기자금대출

- Explain why Regulation Q caused difficulties for banks and other depository institutions, especially during periods of rising interest rates.

Reg Q, one of many “lettered” Fed regulations, originally prohibited banks from paying interest on demand deposits, prohibited thrifts from offering demand deposits, and imposed interest rate ceilings on interest-bearing deposits. These provisions served to limit price competition for deposits in a period when stability was the primary objective. When market rates rose above Reg Q ceilings, deposit withdrawal (disintermediation) would drain liquidity from depository institutions. Ultimately, Reg Q was phased out by the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) and the Depository Institutions Act of 1982. Today, the Fed depends on market forces to allocate flow of funds.

- Explain the sense in which the Fed is “independent”. How independent is the Fed in reality? What is your opinion about the importance of the Fed’s independence for the U.S. economy?

There are no direct channels of bureaucratic, fiscal, or political pressure on the Fed. It is a creature of Congress, but not directly under its authority. The Board is appointed by but not answerable to the President. The Fed funds itself; its income exceeds its expenses by many billions per year, thus Congress has no “power of the purse” over it. Ultimately, however, it may be more correct to say that the Fed is independent within, not of the government. What Congress creates, Congress can modify or destroy. Congress has from time to time established guidelines or objectives for the Fed. The Fed remains independent because most politicians want it that way. They mostly agree that monetary policy is not a partisan issue. An independent Fed can also absorb blame if the economy falters, and take necessary but unpopular steps to combat various economic ills. Critics argue that the Fed’s independence is elitist and undemocratic. Supporters argue that elected politicians cannot be fully trusted to handle the money supply. The underlying argument is as representative government itself: Should popular will decide public policy, or merely decide who decides? There is evidence (see Exhibit 2.5) that countries with more independent central banks have less inflation. However, there is no evidence that central bank independence correlates with employment or national income levels.

- Explain how the Fed changes the money supply with an open market purchase of Treasury securities.

Every Fed transaction with the private sector clears through the “bank reserve account”. When the Fed buys securities, it pays for them in a way no other financial system participant can: It unilaterally creates new money by crediting new reserves in the amount of the purchase to the reserve account of the depository bank of the securities dealer. Thus, open market purchases increase total reserves in the banking system directly, immediately, and dollar-for-dollar. The Fed’s portfolio of U.S. government securities is normally its largest asset.

- Assume the olden days. Three banks A, B and C put $100 each in bullion in a clearing house. Assume someone writes a check for $25 on A and it gets deposited in C, and someone writes a check for $15 on B and it gets deposited in A. After the checks get processed, how much of the bullion is owned by each of the banks?

$90 A, $85 B, $125 C

- According to the “15.2/110.2” schedule, what is a bank’s required reserves if it has $180 million in transaction deposits, $15 million in savings accounts, and $20 million in CDs?

(110.2– 15.2)(.03) + (180 – 110.2)(.10) = $9,830,000 (savings accounts and CDs don’t count)

- The Fed Funds rate is based on a 360-day year. If the Fed Funds rate is 2.25%, what is the interest on borrowing $43 million overnight at this rate?

43,000,000(.0225/360) = $2,687.50 (Fed Funds rate is based on 360-day year)

- Assume a depository institution holds vault cash of $3 million and reserve deposits at the Fed of $25 million, and has borrowed $2 million from the Fed’s discount window. If that institution holds $300 million in transaction deposits and is subject to a 3% reserve requirement on the first $50 million of those deposits and to a reserve requirement of 10% on all transaction deposits over $50 million, what are its required reserves? What are its excess reserves?

RR = 50(0.03)+(300-50)(0.10) = $26.5 million

TR = 25+3-2 = $26 million

ER = -$500,000