Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 168
Chapter 15
ANSWERS TO QUESTIONS
1. If the manager of the open market desk hears that a snowstorm is about to strike New York
City, making it difficult to present checks for payment there and so raising the float, what
defensive open market operations will the manager undertake?
2. During the holiday season, when the public’s holdings of currency increase, what defensive
open market operations typically occur? Why?
3. If the Treasury pays a large bill to defense contractors and as a result its deposits with the
Fed fall, what defensive open market operations will the manager of the open market desk
undertake?
4. If float decreases to below its normal level, why might the manager of domestic operations
consider it more desirable to use repurchase agreements to affect the monetary base, rather
than an outright purchase of bonds?
Because the decrease in float is only temporary, the monetary base is expected to decline
5. “The only way that the Fed can affect the level of borrowed reserves is by adjusting the
discount rate.” Is this statement true, false, or uncertain? Explain your answer.
6. “The federal funds rate can never be above the discount rate.” Is this statement true, false,
or uncertain? Explain your answer.
Uncertain. In theory, the market for reserves model indicates that once the fed funds rate
reaches the discount rate, it would never surpass the discount rate since banks would then
7. “The federal funds rate can never be below the interest rate paid on excess reserves.” Is this
statement true, false, or uncertain? Explain your answer.
Uncertain. In theory, the market for reserves model indicates that once the fed funds rate
reaches the interest rate on excess reserves, it would never go below this rate since banks
8. Why is paying interest on excess reserves an important tool for the Federal Reserve in
managing crises?
9. Why are repurchase agreements used to conduct most short-term monetary policy
operations, rather than the simple, outright purchase and sale of securities?
10. Open market operations are typically repurchase agreements. What does this tell you about
the likely volume of defensive open market operations relative to the volume of dynamic open
market operations?
11. Following the global financial crisis in 2008, assets on the Federal Reserve’s balance sheet
increased dramatically, from approximately $800 billion at the end of 2007 to $3 trillion by
2011. Many of the assets held are longer-term securities acquired through various loan
programs instituted as a result of the crisis. In this situation, how could reverse repos
(matched sale–purchase transactions) help the Fed reduce its assets held in an orderly
fashion, while reducing potential inflationary problems in the future?
Because of the large amount of liquidity in banks and the financial system, this could
eventually lead to substantial inflation problems as liquidity in the form of excess reserves
12. “Discount loans are no longer needed because the presence of the FDIC eliminates the
possibility of bank panics.” Is this statement true, false, or uncertain?
13. What are the disadvantages of using loans to financial institutions to prevent bank panics?
Providing loans to financial institutions creates a moral hazard problem. If firms know that
14. “Considering that raising reserve requirements to 100% makes complete control of the
money supply possible, Congress should authorize the Fed to raise reserve requirements to
this level.” Discuss.
One problem with this proposal is that it provides perfect control over the official measure of
15. Compare the methods of controlling the money supply—open market operations, loans to
financial institutions, and changes in reserve requirements—on the basis of the following
criteria: flexibility, reversibility, effectiveness, and speed of implementation.
Open market operations are more flexible, reversible, and faster to implement than the other
16. What are the advantages and disadvantages of quantitative easing as an alternative to
conventional monetary policy when short-term interest rates are at the zero lower bound?
Since short-term interest rates cannot be lowered below the zero bound in this environment,
17. Why is the composition of the Fed’s balance sheet a potentially important aspect of monetary
policy during an economic crisis?
By purchasing particular types of securities, the Fed can impact interest rates and liquidity in
18. What is the main advantage and the main disadvantage of an unconditional policy
commitment?
Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 172
19. In which economic conditions would a central bank want to use a “forward-guidance”
strategy? Based on your previous answer, can we easily measure the effects of such a
strategy?
In general a central bank would use a strategy of “forward guidance” when other types of
conventional tools of monetary policy cannot affect the economy in the desired way. In
20. How do the monetary policy tools of the European System of Central Banks compare to the
monetary policy tools of the Fed? Does the ECB have a discount lending facility? Does the
ECB pay banks an interest rate on their deposits?
In general the set of monetary policy tools available to the ECB is quite similar to the one at
the Fed’s disposal. The ECB has a discount lending facility, called the marginal lending
21. What is the main rationale behind paying negative interest rates to banks for keeping their
deposits at central banks in Sweden, Switzerland, and Japan? What could happen to these
economies if banks decide to loan their excess reserves, but no good investment
opportunities exist?
22. In early 2016 as the Bank of Japan began to push policy interest rates negative, there was a
sharp increase in sales for home in Japan. Why might this be, and what does it mean for the
effectiveness of negative interest rate policy?
Negative policy interest rates have the effect of making deposit rates at banks negative. Thus,
people can avoid negative returns on holding cash by simply pulling their money out of
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176
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Mishkin •
ANSW
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177
e
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a
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is
Mishkin • Instructor’s Manual for The Economics of Money, Banking, and Financial Markets, Twelfth Edition 178
(DFEDTAR, DFEDTARU, DFEDTARL) and the effective federal funds rate (DFF).
Download into a spreadsheet the data from the beginning of 2006 through the most current
data available.
a. What is the current federal funds target/range, and how does it compare to the effective
federal funds rate?
b. When was the last time the Fed missed its target or was outside the target range? By how
much did it miss?
The last time the Fed missed its target was when it switched from a target of between
c. For each daily observation, calculate the “miss” by taking the absolute value of the
difference between the effective federal funds rate and the target (use the abs(.) function).
For the periods in which the rate was a range, calculate the absolute value of the “miss”
as the amount by which the effective federal funds rate was above or below the range.
What was the average daily miss between the beginning of 2006 and the end of 2007?
What was the average daily miss between the beginning of 2008 and December 15,
2008? What is the average daily miss for the period from December 16, 2008, to the most
current date available? Since 2006, what was the largest single daily miss? Comment on
the Fed’s ability to control the federal funds rate during these three periods.
From the beginning of 2006 to the end of 2007, the average daily miss was 0.05, or 5
basis points. From the beginning of 2008 to December 15, 2008, the average daily miss
was 0.22, or 22 basis points. From December 16, 2008 through July 13, 2017, the federal