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2015 Fall

Money and Banking
4 December 2015
Prof. Nguyen Xuan Hai
ECON3410A — Money and Banking
Fall 2015
Final Exam
This is a 165-­‐minute exam with three main parts, worth a total of 100 points. For the
multiple-­‐choice part, you must clearly indicate your Qinal answer. For other parts, you must
give clear, concise, and correct answers, including all necessary explanations. There are no
trick questions. If something is confusing, please ask for clariQication. If it remains
confusing, simply state clearly your assumptions and I will grade accordingly. Books and
notes are NOT permitted.
Futhermore, please note the followings:
(1) Write down ALL your answers on the Answer Book. We will examine your Answer
Book-­‐-­‐-­‐and your Answer Book only! Nothing else will be graded.
(2) Make sure your handwriting is legible. If we cannot read something, it is WRONG by
default and will receive no credit.
(3) Plagiarism and cheating will be penalized to the fullest extent of University
Good luck!
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Part I -­‐-­‐ Multiple Choice (1 point each -­‐-­‐ total of 30 points)
1) A major disruption in Qinancial markets characterized by sharp declines in
asset prices and Qirm failures is called a
A) "lemons" problem.
B) Qinancial crisis.
C) Qiscal imbalance.
D) free-­‐rider problem.
2) A serious consequence of a Qinancial crisis is
A) an increase in asset prices.
B) Qinancial globalization.
C) Qinancial engineering.
D) a contraction in economic activity.
3) If uncertainty about banks' health causes depositors to begin to withdraw
their funds from banks, the country experiences a(n)
A) Qinancial recovery.
B) increase in information available to investors.
C) banking crisis.
D) reduction of the adverse selection and moral hazard problems.
4) A possible sequence for the three stages of a Qinancial crisis might be ________
leads to ________ leads to ________.
A) asset price declines; banking crises; unanticipated decline in price level
B) banking crises; increase in uncertainty; increase in interest rates
C) banking crises; increase in interest rates; unanticipated decline in price
D) unanticipated decline in price level; banking crises; increase in interest
5) Microprudential supervision does all of the following EXCEPT
A) checking capital ratios of a bank.
B) assessing the riskiness of an individual bank's activities.
C) focusing on Qinancial system liquidity.
D) checking a bank's compliance with disclosure requirements.
6) Macroprudential supervision policies try to prevent a leverage cycle by
changing capital requirements so that they ________ during an expansion and
________ during a downturn.
A) decrease; increase
B) increase; decrease
C) decrease; decrease
D) increase; increase
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7) A Qinancial crisis occurs when an increase in asymmetric information from a
disruption in the Qinancial system
A) increases economic activity.
B) reduces uncertainty in the economy and increases market efQiciency.
C) causes severe adverse selection and moral hazard problems that make
Qinancial markets incapable of channeling funds efQiciently.
D) allows for a more efQicient use of funds.
8) Factors likely to cause a Qinancial crisis in emerging market countries include
A) severe Qiscal imbalances.
B) too strong oversight of the Qinancial industry.
C) decreases in foreign interest rates.
D) a foreign exchange crisis.
9) A sharp depreciation of the domestic currency after a currency crisis leads to
A) decrease in the value of foreign currency-­‐denominated liabilities.
B) lower interest rates.
C) lower import prices.
D) higher inQlation.
10) The monetary base consists of
A) currency in circulation and the U.S. Treasury's monetary liabilities.
B) reserves and Federal Reserve Notes.
C) currency in circulation and Federal Reserve notes.
D) currency in circulation and reserves.
11) The interest rate the Fed charges banks borrowing from the Fed is the
A) discount rate.
B) prime rate.
C) Treasury bill rate.
D) federal funds rate.
12) If the Fed decides to reduce bank reserves, it can
A) purchase government bonds.
B) sell government bonds.
C) print more currency.
D) extend discount loans to banks.
13) When the Fed supplies the banking system with an extra dollar of reserves,
deposits ________ by ________ than one dollara process called multiple deposit
A) increase; less
B) decrease; more
C) decrease; less
D) increase; more
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14) An increase in the nonborrowed monetary base, everything else held constant,
will cause
A) demand deposits to fall.
B) the money supply to rise.
C) no change in the money supply.
D) the money supply to fall.
15) Everything else held constant, an increase in currency holdings will cause
A) checkable deposits to rise.
B) the money supply to fall.
C) the money supply to remain constant.
D) the money supply to rise.
16) Everything else held constant, a decrease in holdings of excess reserves will
A) a decrease in checkable deposits.
B) an increase in discount loans.
C) a decrease in the money supply.
D) an increase in the money supply.
17) The ratio that relates the change in the money supply to a given change in the
monetary base is called the
A) deposit ratio.
B) required reserve ratio.
C) discount rate.
D) money multiplier.
18) If the Fed injects reserves into the banking system and they are held as excess
reserves, then the monetary base ________ and the money supply ________.
A) remains unchanged; increases
B) increases; increases
C) remains unchanged; remains unchanged
D) increases; remains unchanged
19) Everything else held constant, a decrease in the required reserve ratio on
checkable deposits will mean
A) an increase in discount loans.
B) a decrease in the money supply.
C) a decrease in checkable deposits.
D) an increase in the money supply.
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20) Open market purchases raise the ________ thereby raising the ________.
A) monetary base; money supply
B) monetary base; money multiplier
C) money multiplier; money supply
D) money multiplier; monetary base
21) The Fed's lender-­‐of-­‐last-­‐resort function
A) creates a moral hazard problem.
B) is no longer necessary due to FDIC insurance.
C) has proven to be ineffective.
D) cannot prevent runs by large depositors.
22) The Fed's open market operations normally involve only the purchase of
government securities, particularly those that are short-­‐term. However,
during the crisis, the Fed started new programs to purchase
A) mortgage-­‐backed securities and long-­‐term Treasuries.
B) commercial papers and short-­‐term Treasuries.
C) Treasury bills and Treasury notes.
D) mortgage-­‐backed securities and Treasury bills.
23) The most common deQinition that monetary policymakers use for price
stability is
A) high and stable inQlation.
B) low and stable inQlation.
C) low and stable deQlation.
D) an inQlation rate of zero percent.
24) The theory that monetary policy conducted on a discretionary, day-­‐by-­‐day
basis leads to poor long-­‐run outcomes is referred to as the
A) nominal-­‐anchor problem.
B) moral hazard problem.
C) adverse selection problem.
D) time-­‐inconsistency problem.
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25) Even if the Fed could completely control the money supply, monetary policy
would have critics because
A) it is required to keep Treasury security prices high.
B) the Fed's primary goal is exchange rate stability, causing it to ignore
domestic economic conditions.
C) the Fed's goals do not include high employment, making labor unions a
critic of the Fed.
D) the Fed is asked to achieve many goals, some of which are incompatible
with others.
26) Which set of goals can, at times, conQlict in the short run?
A) high employment and price level stability
B) interest rate stability and Qinancial market stability
C) exchange rate stability and Qinancial market stability
D) high employment and economic growth
27) Either a dual or hierarchial mandate for central banks is acceptable as long as
________ is the primary goal in the ________.
A) reducing business-­‐cycle Qluctuations; short run
B) price stability; short run
C) price stability; long run
D) reducing business-­‐cycle Qluctuations; long run
28) An increase in the domestic interest rate causes the demand for domestic
assets to ________ and the domestic currency to ________, everything else held
A) decrease; appreciate
B) increase; appreciate
C) increase; depreciate
D) decrease; depreciate
29) A decrease in the expected future exchange rate causes the demand for
domestic assets to ________ and the domestic currency to ________, everything
else held constant.
A) increase; depreciate
B) increase; appreciate
C) decrease; appreciate
D) decrease; depreciate
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30) Suppose the Federal Reserve releases a policy statement today which leads
people to believe that the Fed will be enacting expansionary monetary policy
in the near future. Everything else held constant, the release of this statement
would immediately cause the demand for U.S. assets to ________ and the U.S.
dollar to ________.
A) decrease; appreciate
B) decrease; depreciate
C) increase; appreciate
D) increase; depreciate
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Part II -­‐-­‐ Short Answers (5 points each -­‐-­‐ total of 50 points)
1) What two key factors trigger speculative attacks leading to currency cries in
emerging market countries?
2) Explain two reasons why the Fed does not have complete control over the
level of bank deposits and loans. Explain how a change in either factor affects
the deposit expansion process.
3) Explain the time-­‐inconsistency problem. What is the likely outcome of
discretionary policy? What are the solutions to the time-­‐inconsistency
4) State the equation and explain the economic intuition for the Okun's Law.
5) State the equation and explain the economic intuition for the Phillips Curve.
6) State the equation and explain the economic intuition for the Taylor Rule.
7) The Okun's Law, Phillips Curve, and Taylor Rule have lent support to the
relationship between interest rates, inQlation, unemployment, and output
growth. In particular, there is an empirically negative relationship between
unemployment and output growth; an empirical trade-­‐off between output and
inQlation; and an empirical link between interest rates, inQlation, and output
Explain why it is unwise for policymakers to rely exclusively on these rules
when managing the money supply.
8) What is systemic risk? Why does it attract so much attention during the most
recent Qinancial crisis (2007-­‐09)?
9) Describe the basic aspects of the originate-­‐to-­‐distribute model of banking.
What are the advantages and disadvantages of this model, compared to the
traditional originate-­‐to-­‐hold model?
10) Explain the basic process and rationale for Quantitative Easing (QE). Why is
QE important to the most recent Qinancial crisis (2007-­‐09)?
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Part III -­‐-­‐ Problem Sets (4 points each -­‐-­‐ total of 20 points)
Let us consider a country, named Gladiata. Let us suppose that Gladiata is currently a part
of a currency union, called Europa Fantasia, or EF for short. The common currency in use is
called the EuFa. The supply of the EuFa is determined solely and independently by the EF
Central Bank, EFCB. In particular, Gladiata has no inQluence on EFCB. Meanwhile, capital
Qlows freely within the EF.
Now, suppose that we are in year 3015, during which Gladiata has been hit by an economic
shock. Gladiata's unemployment is high, while its GDP growth is falling fast.
Finally, suppose that you are the Prime Minister of Gladiata and you will have to make
decisions to revive Gladiata's economic conditions.
1) Using the Uncovered Interest Rate Parity (and maybe Mundell's trilemma),
explain why you cannot lower Gladiata's interest rates to stimulate the
Now, suppose you decide unilaterally that Gladiata will leave the EF immediately. You
institute a new domestic currency, called the Glad. Every EuFa within Gladiata's economy is
also immediately converted into Glad, at a one-­‐to-­‐one rate.
2) Will you also print additional Glad to stimulate the economy? Why or why
Suppose Gladiators (citizens of Gladiata) currently hold 1 Glad in cash for every 4 Glads in
Suppose Gladiator banks hold 1 Glad in reserve for every 4 Glads of deposits.
A simple calculation reveals that the money multiplier in Gladiata stands currently at 2.5.
3) Suppose you have printed an extra 2% of Glad and injected it into the
economy. By how much do you expect the money supply to increase? Knowing
the uncovered Interest Rate Parity, do you expect the Glad to appreciate or
depreciate relative to the EuFa? By more or less than the percentage increase
in the money supply? Explain.
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4) Unfortunately, your decision to leave the EF and print new money has sparked
a banking panic in the country. In particular, Gladiators (citizen of Gladiata)
decides to run on their deposits while banks restrict lending and increase
their cash holdings.
What are the immediate consequences of this panic on the money supply and
the exchange rate, relative to your answers in the previous question?
5) Discuss some possible macroeconomic impacts of the banking panic on the
economy of Gladiata in this setting.
Bonus Question (5 points)
Given this analysis, do you think the decision to leave the EF is optimal? What
would you have done differently? Explain your reasoning.
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