The Economics of Contemporary Banking: Conceptual Questions and Solutions

Problem 41. What is the discount rate?

(a) The amount of funds that a depository institution must hold in reserve against deposit liabilities.
(b) The rate other banks in the Federal Reserve system charge each other for overnight loans.
(c) The rate at which the Fed charges banks for overnight loans.
(d) The rate which the Fed charges the government for loans.
(e) The target interest rate which the Fed seeks to bring about.
(f) The currency-deposit ratio that the Fed mandates for the economy.

Solution 41. The discount rate is

(c): The rate at which the Fed charges banks for overnight loans.

Problem 42. Which of these statements about the federal funds rate (ffr) are true? More than one answer is possible.

(a) The ffr rate other banks in the Federal Reserve system charge each other for overnight loans.
(b) The ffr is the rate at which the Fed charges banks for overnight loans.
(c) The ffr is the rate which the Fed charges the government for loans.
(d) The ffr is most often greater than the discount rate.
(e) The ffr is most often less than the discount rate.
(f) The ffr is the same as the discount rate.

Solution 42. The following statements about the federal funds rate (ffr) are true:

(a): The ffr rate other banks in the Federal Reserve system charge each other for overnight loans.
(e): The ffr is most often less than the discount rate. It is desirable for banks to first try to lend to each other before resorting to the Fed.

Problem 43. In which of these situations would high-powered money be created? More than one answer is possible.

(a) The Fed purchases gold and pays by adding liabilities to its balance sheets.
(b) There are no excess bank reserves, and the Fed increases the reserve requirement on banks.
(c) The amount of currency in the economy declines sharply.
(d) The Fed purchases government securities and pays by adding liabilities to its balance sheets.
(e) The Fed purchases foreign currency and pays by adding liabilities to its balance sheets.
(f)The Fed sells government securities, collects the monetary proceeds, and keeps the money in its vaults.

Solution 43. High-powered money is defined as H = CU + R. Increasing CU or R will, ceteris paribus, create high-powered money. Situations where this occurs include

(a): The Fed purchases gold and pays by adding liabilities to its balance sheets.
(b): There are no excess bank reserves, and the Fed increases the reserve requirement on banks.
(d): The Fed purchases government securities and pays by adding liabilities to its balance sheets.
(e): The Fed purchases foreign currency and pays by adding liabilities to its balance sheets.

Problem 44. Which of these statements about bank runs are true? More than one answer is possible.

(a) The Fed today tries to prevent bank runs by attempting to reduce the amount high-powered money.
(b) Bank runs are impossible on a bank that holds 100% reserves.
(c) Bank runs stopped altogether with the advent of federal deposit insurance (FDIC).
(d) Bank runs tend to be isolated and have no effect on overall confidence in the economy.
(e) The Fed today tries to bail out certain large banks thought to be "too big to fail."
(f) Federal deposit insurance (FDIC) was the first attempt to protect depositors against the consequences of bank runs.

Solution 44. The following statements are true:
(b): Bank runs are impossible on a bank that holds 100% reserves.
(e): The Fed today tries to bail out certain large banks thought to be "too big to fail."

Problem 45. Which of these statements about moral hazard are true? More than one answer is possible.

(a) The reckless behavior of some teenagers can be considered a case of moral hazard.
(b) The risk-taking of an entrepreneur who has invested his life savings in a project can be considered a case of moral hazard.
(c) The Fed bailing out banks deemed "too big to fail" creates a moral hazard.
(d) Moral hazard is a type of principal-agent problem.
(e) Moral hazard facilitates irresponsible behavior.
(f) When economic functions, roles, and duties are determined on a private property basis rather than a socialized basis, moral hazard is more prevalent.
(g) Moral hazard entails the consequences of an agent's behavior being partially shared by his principal.
(h) Moral hazard occurs when an individual fully suffers the consequences of his actions; thereby, the alleged "morality" of full individual responsibility is hazardous to individual actors having to bear the brunt of it.

Solution 45. The following statements about moral hazard are true:
(a): The reckless behavior of some teenagers can be considered a case of moral hazard.
(c): The Fed bailing out banks deemed "too big to fail" creates a moral hazard.
(d): Moral hazard is a type of principal-agent problem.
(e): Moral hazard facilitates irresponsible behavior.
(g): Moral hazard entails the consequences of an agent's behavior being partially shared by his principal.

See Mr. Stolyarov's complete index of Intermediate Macroeconomics Problems and Solutions here.