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What is a "liquidity crisis" (bank run)?
No bank ever has enough ready cash to simultaneous close all checking accounts
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What is deposit insurance (FDIC)?
- FDIC-federal deposit insurance corporation
- Insures money in your account up to 250,000.
- Bank pays insurance premium.
- Tax payers pay if insurance doesn't have money to pay
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Define Bank Failue. Give an example of something that can cause a bank failure.
- Liabilities are more than assets.
- Example alot of bad loans
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What happens to owner's equity during a bank failure?
The owners equity goes to zero (broke)
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Our government paid billions for the Bank "rescue" plan in fall, 2008. What were the two main things the money was used for?
- A. Government buys the bad loans from the banks
- B. Inject owner's equity into the banks (gov becomes co-owner)
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What is the meaning of the phrase "too big to fail"?
If large banks fail it would be too disruptive to the overall economy. (Job loss, business failure)
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In the past (50s and 60s), what did banks and savings and loans do with mortgage loans that they made?
- Banks loan money to homebuyers, and banks hold the loans.
- Bank profits-depends on borrower to repay loans & bank earns interest
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In recent years, what did banks, savings and loans, and other lenders do with most (sometimes all) mortagage loans that they made?
- Banks loan money to home buyers and sell loan to other investers
- Bank profits- fees
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How did lender incentives, with respect to mortgages, change from the 60s-90s, and 2000s?
- A. Past Incentives- make careful loans (good loans). Ability to pay loans bases on Income and job
- B. Current Incentives- make lots of loans, maximize fees and income. Ability to pay based on expected future increase in price of house.
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Fannie Mae and Freddie Mac are two large government sponsered financial intermediaries that facilitate home ownership. Descripe how they operate.
- They buy mortgages from banks and hold them.
- Resells them to other investers.
- Insures mortgages, earns a fee
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How did the housing market contribute to the current financial crisis?
Draw graph. Demand for houses kept increasing supply stayes the same
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Breifly describe the Federal Reserve System (The FED)
- Indepentant Agency Part of the US government
- Created by Act of Congress-1914 Federal Reserve Act
- Ron Paul-wants to abolish Federal Reserves
- Congress divided US in 12 Geographic Regions creating 12 Regional Federal Reserve Banks, each headed by a regional federal bank president
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Who is the current Secretary of Treasury?
Tim Geithner
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How are the 7 members of the Federal Reserve Board of Governers choses?
Appointed by President of the US, Confirmed by US Senate, to a 14 year term, non-renewable
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Who is the Chairman of the Federal Reserve Board of Governers? When was he appointed as Chair? When does his term as Chair end? Who appoints the Fed Chairman?
- Ben Bernanke
- 1st appointed in 2006 by bush, and in 2010 by obama
- Term ends in 2014
- The president appoints fed chairman to a renewable 4 year term
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What are the names of two previous Fed Chairmen?
- Alan Greenspan 1987-2006
- Paul Volcker 1979-1987
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Who are the 12 members of the Federal Open Market Committee?
- 12 members include 7 members of the Federal Board of governers and 5 of the Presidents of Regional Federal Banks
- they meet every 6 weeks
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What are the 5 functions of the federal Reserve System?
- Fed regulates banks (set reserve ratio)
- Fed acts as a banker for banks (lend money to banks)
- Fed acts as banker for US Government{treasury} (lend mony to government)
- FED issues paper Currency(printed at Bureaua of printing and engraving new currency 120 billion)
- FED controls the size of money supply (M1)
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Monetary Policy
A deliberate change in the size of nation's money supply done by the FEDs in order to influence the overall economy. change-increase(expansionary) or decrease (contractionary) M1
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What are the 3 "monetary tools" the Fed uses to alter the money supply?
- Reserve ratio
- Discount rate
- Open market operations
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Describe effect on the level of bank loans and money supply if Fed decreases reserve ratio. (4)
- Decrease required reserves
- Increase excess reserves
- Banks can make more loans
- Increase the money supply
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Describe effect on the level of bank loans and money supply if Fed increases reserve ratio. (4)
- Increase required reserves
- Decrease excess reserves
- Banks make fewer loans
- Decrease money supply
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Discount Rate
Interest rate charged by the Fed when the Fed lends dollar reserves to a bank. Fed set discount rate 3/4 %
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Prime Interest Rate
Interest rate on a loan from bank to customer. (higher than discount rate for profit)
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Describe effect on the level of bank loans and money supply if Fed lowers discount rate on loans to banks. (4)
- Bank is charges lower interest rate by Fed
- Banks can charge a lower interest rate to customer
- More loans
- Increase money supply
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Describe effect on the level of bank loans and money supply if Fed raises the discount rate on loans to banks. (4)
- Bank is charges higher interest rate by Fed
- Banks will charge a higher interest rate to customer
- Fewer loans
- Decrease money supply
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US Government Securities
- Loans to the US government at some specified interest rate and for some time perieod
- Are issued by the US Treasury when the government borrows money
- Why? Budget deficeit government spends more than they collect in taxes
- Most can be resold to other investors
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Explain the effect on excess reserves and the money supply when the fed purchases US government securities from banks.
- Fed pays bank in reserves
- bank have more excess reserves
- bank make more loans
- M1 up
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Explain the effect on excess reserves and the money supply when the fed sells US government securities to banks.
- Bank pays fed in reserves
- bank have less excess reserves
- bank make fewer loans
- M1 down
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Explain the effect on excess reserves and the money supply when the Fed purchases US government securities from the US Treasury: assume the treasury spends the money.
- US treasury spends newly created money (by Fed) into economy
- Increase money supply
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Explain how increase in the money supply could lead to change in the interest rate. Show on Graph
- increase supply of loan
- decrease interest rate
- more loans
- increae spending
- increase GDP
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Trade-offs of in the use of expansionary monetary policy
- pros:
- increase spending, increase production, increase jobs, lower interest rates(borrowers)
- cons:
- Banks don't lend to business & consumers,can cause inflation,can cause bad loans, can increase level of consumer debt, can cause trade deficit, lower interest rates (savers)
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Explain how decrease in the money supply could lead to change in the interest rate. Show on Graph
- decrease supply of loan
- increase interest rate
- Excess reserves down
- fewer loans
- decrease spending
- lowers GDP
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Trade offs in the use of contractionary Monetary Policy
- Pros:
- decrease spending, can prevent inflation, high interest rates(savers), encourage savings
- Cons:
- high interest rate (borrowers), can cause recession, high unemployment
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Explain how change in the "Demand for Loans" can lead to interest rate change. Show on graph
- Increase in demand for loans interest rate up
- Decreae in demand for loans interest rate down
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Economic growth
Increase in nation's capacity to produce products
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Growth rate
- percentage increase in our nation's capacity to produce products
- 3-4 % good, 1-2% average
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Productivity
Number of products produced per worker per hour
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What are the sources of productivity growth? (4)
- better technology
- Better labor-education, training, skills
- Better management
- More investment goods-computers, tools, equipment
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What is the relationship between investment spending and economic growth?
More investment spending leads to faster economic groth
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What has been the trend in U.S productivity growth since 1950?
- 50-75 productivity growth averaged +3% per year (economy grows 3% each year) fast
- 75-2010 productivity growth averaged 1 1/2 % per year (economy grows 1 1/2% per year) slow
- Trend- slowed down from 75 until today
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What has caused the trend? (3)
- Transition to information based economy
- Outsourcing
- Financial deregulation
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What is the relationship between productivity growth and average real income?
Productivity growth dictates(equals) average real income
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