This Document Contains Chapters 12 to 13 Chapter 12 Banking Industry: Structure and Competition 12.1 Historical Development of the Banking System 1) The modern commercial banking system began in America when the A) Bank of United States was chartered in New York in 1801. B) Bank of North America was chartered in Philadelphia in 1782. C) Bank of United States was chartered in Philadelphia in 1801. D) Bank of North America was chartered in New York in 1782. Answer: B 2) A major controversy involving the banking industry in its early years was A) whether banks should both accept deposits and make loans or whether these functions should be separated into different institutions. B) whether the federal government or the states should charter banks. C) what percent of deposits banks should hold as fractional reserves. D) whether banks should be allowed to issue their own bank notes. Answer: B 3) The government institution that has responsibility for the amount of money and credit supplied in the economy as a whole is the A) central bank. B) commercial bank. C) bank of settlement. D) monetary fund. Answer: A 4) Because of the abuses by state banks and the clear need for a central bank to help the federal government raise funds during the War of 1812, Congress created the A) Bank of United States in 1812. B) Bank of North America in 1814. C) Second Bank of the United States in 1816. D) Second Bank of North America in 1815. Answer: C 5) The Second Bank of the United States was denied a new charter by A) President Andrew Jackson. B) Vice President John Calhoun. C) President Benjamin Harrison. D) President John Q. Adams. Answer: A 6) Currency circulated by banks that could be redeemed for gold was called ________. A) junk bonds B) banknotes C) gold bills D) state money Answer: B 7) To eliminate the abuses of the state-chartered banks, the ________ created a new banking system of federally chartered banks, supervised by the ________. A) National Bank Act of 1863; Office of the Comptroller of the Currency B) Federal Reserve Act of 1863; Office of the Comptroller of the Currency C) National Bank Act of 1863; Office of Thrift Supervision D) Federal Reserve Act of 1863; Office of Thrift Supervision Answer: A 8) The belief that bank failures were regularly caused by fraud or the lack of sufficient bank capital explains, in part, the passage of A) the National Bank Charter Amendments of 1918. B) the Garn-St. Germain Act of 1982. C) the National Bank Act of 1863. D) Federal Reserve Act of 1913. Answer: C 9) Before 1863, A) federally-chartered banks had regulatory advantages not granted to state-chartered banks. B) the number of federally-chartered banks grew at a much faster rate than at any other time since the end of the Civil War. C) banks acquired funds by issuing bank notes. D) banks were required to maintain 100% of their deposits as reserves. Answer: C 10) Although the National Bank Act of 1863 was designed to eliminate state-chartered banks by imposing a prohibitive tax on banknotes, these banks have been able to stay in business by A) issuing credit cards. B) ignoring the regulations. C) acquiring funds through deposits. D) branching into other states. Answer: C 11) The National Bank Act of 1863, and subsequent amendments to it, A) created a banking system of state-chartered banks. B) established the Office of the Comptroller of the Currency. C) broadened the regulatory powers of the Federal Reserve. D) created insurance on deposit accounts. Answer: B 12) Which regulatory body charters national banks? A) The Federal Reserve B) The FDIC C) The Comptroller of the Currency D) The U.S. Treasury Answer: C 13) The regulatory system that has evolved in the United States whereby banks are regulated at the state level, the national level, or both, is known as a A) bilateral regulatory system. B) tiered regulatory system. C) two-tiered regulatory system. D) dual banking system. Answer: D 14) Today the United States has a dual banking system in which banks supervised by the ________ and by the ________ operate side by side. A) federal government; municipalities B) state governments; municipalities C) federal government; states D) municipalities; states Answer: C 15) The U.S. banking system is considered to be a dual system because A) banks offer both checking and savings accounts. B) it actually includes both banks and thrift institutions. C) it is regulated by both state and federal governments. D) it was established before the Civil War, requiring separate regulatory bodies for the North and South. Answer: C 16) The Federal Reserve Act of 1913 required that A) state banks be subject to the same regulations as national banks. B) national banks establish branches in the cities containing Federal Reserve banks. C) national banks join the Federal Reserve System. D) state banks could not join the Federal Reserve System. Answer: C 17) The Federal Reserve Act required all ________ banks to become members of the Federal Reserve System, while ________ banks could choose to become members of the system. A) state; national B) state; municipal C) national; state D) national; municipal Answer: C 18) Probably the most significant factor explaining the drastic drop in the number of bank failures since the Great Depression has been A) the creation of the FDIC. B) rapid economic growth since 1941. C) the employment of new procedures by the Federal Reserve. D) better bank management. Answer: A 19) With the creation of the Federal Deposit Insurance Corporation, member banks of the Federal Reserve System ________ to purchase FDIC insurance for their depositors, while non-member commercial banks ________ to buy deposit insurance. A) could choose; were required B) could choose; were given the option C) were required, could choose D) were required; were required Answer: C 20) With the creation of the Federal Deposit Insurance Corporation, A) member banks of the Federal Reserve System were given the option to purchase FDIC insurance for their depositors, while non-member commercial banks were required to buy deposit insurance. B) member banks of the Federal Reserve System were required to purchase FDIC insurance for their depositors, while non-member commercial banks could choose to buy deposit insurance. C) both member and non-member banks of the Federal Reserve System were required to purchase FDIC insurance for their depositors. D) both member and non-member banks of the Federal Reserve System could choose, but were not required, to purchase FDIC insurance for their depositors. Answer: B 21) The Glass-Steagall Act, before its repeal in 1999, prohibited commercial banks from A) issuing equity to finance bank expansion. B) engaging in underwriting and dealing of corporate securities. C) selling new issues of government securities. D) purchasing any debt securities. Answer: B 22) The legislation that separated investment banking from commercial banking until its repeal in 1999 is known as the: A) National Bank Act of 1863. B) Federal Reserve Act of 1913. C) Glass-Steagall Act. D) McFadden Act. Answer: C 23) Which of the following statements concerning bank regulation in the United States are true? A) The Office of the Comptroller of the Currency has the primary responsibility for state banks that are members of the Federal Reserve System. B) The Federal Reserve and the state banking authorities jointly have responsibility for the 900 state banks that are members of the Federal Reserve System. C) The Office of the Comptroller of the Currency has sole regulatory responsibility over bank holding companies. D) The state banking authorities have sole regulatory responsibility for all state banks. Answer: B 24) Which bank regulatory agency has the sole regulatory authority over bank holding companies? A) The FDIC B) The Comptroller of the Currency C) The FHLBS D) The Federal Reserve System Answer: D 25) State banks that are not members of the Federal Reserve System are most likely to be examined by the A) Federal Reserve System. B) FDIC. C) FHLBS. D) Comptroller of the Currency. Answer: B 26) State banking authorities have sole jurisdiction over state banks A) without FDIC insurance. B) that are not members of the Federal Reserve System. C) operating as bank holding companies. D) chartered in the 21st century. Answer: A 12.2 Financial Innovation and the Growth of the "Shadow Banking System" 1) Financial innovations occur because of financial institutions search for ________. A) profits B) fame C) stability D) recognition Answer: A 2) ________ is the process of researching and developing profitable new products and services by financial institutions. A) Financial engineering B) Financial manipulation C) Customer manipulation D) Customer engineering Answer: A 3) The most significant change in the economic environment that changed the demand for financial products in recent years has been A) the aging of the baby-boomer generation. B) the dramatic increase in the volatility of interest rates. C) the dramatic increase in competition from foreign banks. D) the deregulation of financial institutions. Answer: B 4) In the 1950s the interest rate on three-month Treasury bills fluctuated between 1 percent and 3.5 percent; in the 1980s it fluctuated between ________ percent and ________ percent. A) 5; 15 B) 4; 11.5 C) 4; 18 D) 5; 10 Answer: A 5) Uncertainty about interest-rate movements and returns is called ________. A) market potential B) interest-rate irregularities C) interest-rate risk D) financial creativity Answer: C 6) Rising interest-rate risk A) increased the cost of financial innovation. B) increased the demand for financial innovation. C) reduced the cost of financial innovation. D) reduced the demand for financial innovation. Answer: B 7) Adjustable rate mortgages A) protect households against higher mortgage payments when interest rates rise. B) keep financial institutions' earnings high even when interest rates are falling. C) benefit homeowners when interest rates are falling. D) generally have higher initial interest rates than on conventional fixed-rate mortgages. Answer: C 8) The agreement to provide a standardized commodity to a buyer on a specific date at a specific future price is A) a put option. B) a call option. C) a futures contract. D) a mortgage-backed security. Answer: C 9) An instrument developed to help investors and institutions hedge interest-rate risk is A) a put option. B) a call option. C) a financial derivative. D) a mortgage-backed security. Answer: C 10) Financial instruments whose payoffs are linked to previously issued securities are called ________. A) grandfathered bonds B) financial derivatives C) hedge securities D) reversible bonds Answer: B 11) Both ________ and ________ were financial innovations that occurred because of interest rate risk volatility. A) adjustable-rate mortgages; commercial paper B) adjustable-rate mortgages; financial derivatives C) sweep accounts; financial derivatives D) sweep accounts; commercial paper Answer: B 12) The most important source of the changes in supply conditions that stimulate financial innovation has been the A) deregulation of financial institutions. B) dramatic increase in the volatility of interest rates. C) improvement in computer and telecommunications technology. D) dramatic increase in competition from foreign banks. Answer: C 13) New computer technology has A) increased the cost of financial innovation. B) increased the demand for financial innovation. C) reduced the cost of financial innovation. D) reduced the demand for financial innovation. Answer: C 14) Credit cards date back to A) prior to the second World War. B) just after the second World War. C) the early 1950s. D) the late 1950s. Answer: A 15) A firm issuing credit cards earns income from A) loans it makes to credit card holders. B) subsidies from the local governments. C) payments made to it by manufacturers of the products sold in stores on credit card purchases. D) sales of the card in foreign countries. Answer: A 16) The entry of AT&T and GM into the credit card business is an indication of A) government's efforts to deregulate the provision of financial services. B) the rising profitability of credit card operations. C) the reduction in costs of credit card operations since 1990. D) the sale of unprofitable operations by Bank of America and Citicorp. Answer: B 17) A debit card differs from a credit card in that A) a debit card is a loan while for a credit card purchase, payment is made immediately. B) a debit card is a long-term loan while a credit card is a short-term loan. C) a credit card is a loan while for a debit card purchase, payment is made immediately. D) a credit card is a long-term loan while a debit card is a short-term loan. Answer: C 18) Automated teller machines A) are more costly to use than human tellers, so banks discourage their use by charging more for use of ATMs. B) cost about the same to use as human tellers in banks, so banks discourage their use by charging more for use of ATMs. C) cost less than human tellers, so banks may encourage their use by charging less for using ATMs. D) cost nothing to use, so banks provide their services free of charge. Answer: C 19) The declining cost of computer technology has made ________ a reality. A) brick and mortar banking B) commercial banking C) virtual banking D) investment banking Answer: C 20) Bank customers perceive Internet banks as being A) more secure than physical bank branches. B) a better method for the purchase of long-term savings products. C) better at keeping customer information private. D) prone to many more technical problems. Answer: D 21) A disadvantage of virtual banks (clicks) is that A) their hours are more limited than physical banks. B) they are less convenient than physical banks. C) they are more costly to operate than physical banks. D) customers worry about the security of on-line transactions. Answer: D 22) So-called fallen angels differ from junk bonds in that A) junk bonds refer to newly issued bonds with low credit ratings, whereas fallen angels refer to previously bonds that have had their credit ratings fall below Baa. B) junk bonds refer to previously bonds that have had their credit ratings fall below Baa, whereas fallen angels refer to newly issued bonds with low credit ratings. C) junk bonds have ratings below Baa, whereas fallen angels have ratings below C. D) fallen angels have ratings below Baa, whereas junk bonds have ratings below C. Answer: A 23) Newly-issued high-yield bonds rated below investment grade by the bond-rating agencies are frequently referred to as A) municipal bonds. B) Yankee bonds. C) "fallen angels." D) junk bonds. Answer: D 24) In 1977, he pioneered the concept of selling new public issues of junk bonds for companies that had not yet achieved investment-grade status. A) Michael Milken B) Roger Milliken C) Ivan Boskey D) Carl Ichan Answer: A 25) One factor contributing to the rapid growth of the commercial paper market since 1970 is A) the fact that commercial paper has no default risk. B) improved information technology making it easier to screen credit risks. C) government regulation. D) FDIC insurance for commercial paper. Answer: B 26) The development of money market mutual funds contributed to the growth of ________ since the money market mutual funds need to hold liquid, high-quality, short-terms assets. A) the commercial paper market B) the municipal bond market C) the corporate bond market D) the junk bond market Answer: A 27) The process of transforming otherwise illiquid financial assets into marketable capital market instruments is know as A) securitization. B) internationalization. C) arbitrage. D) program trading. Answer: A 28) ________ is creating a marketable capital market instrument by bundling a portfolio of mortgage or auto loans. A) diversification. B) arbitrage. C) computerization. D) securitization. Answer: D 29) The driving force behind the securitization of mortgages and automobile loans has been A) the rising regulatory constraints on substitute financial instruments. B) the desire of mortgage and auto lenders to exit this field of lending. C) the improvement in computer technology. D) the relaxation of regulatory restrictions on credit card operations. Answer: C 30) According to Edward Kane, because the banking industry is one of the most ________ industries in America, it is an industry in which ________ is especially likely to occur. A) competitive; loophole mining B) competitive; innovation C) regulated; loophole mining D) regulated; innovation Answer: C 31) Loophole mining refers to financial innovation designed to A) hide transactions from the IRS. B) conceal transactions from the SEC. C) get around regulations. D) conceal transactions from the Treasury Department. Answer: C 32) Prior to 2008, bank managers looked on reserve requirements A) as a tax on deposits. B) as a subsidy on deposits. C) as a subsidy on loans. D) as a tax on loans. Answer: A 33) Prior to 2008, the bank's cost of holding reserves equalled A) the interest paid on deposits times the amount of reserves. B) the interest paid on deposits times the amount of deposits. C) the interest earned on loans times the amount of loans. D) the interest earned on loans times the amount on reserves. Answer: D 34) Prior to 1980, the Fed set an interest rate ________ that is a maximum limit on the interest rate that could be paid on time deposits. A) floor B) ceiling C) wall D) window Answer: B 35) The process in which people take their funds out of the banking system seeking higher -yielding securities is called A) capital mobility. B) loophole mining. C) disintermediation. D) deposit jumping. Answer: C 36) Money market mutual funds A) function as interest-earning checking accounts. B) are legally deposits. C) are subject to reserve requirements. D) have an interest-rate ceiling. Answer: A 37) In September 2008, the Reserve Primary Fund, a money market mutual fund, found itself in the situation know as "breaking the buck." This means that A) they could no longer afford to redeem shares at the par value of $1. B) they required shareholders to contribute a dollar more in fees each month. C) shareholders were able to redeem shares for more than a $1. D) shares earned more than a dollar in interest. Answer: A 38) In this type of arrangement, any balances above a certain amount in a corporation's checking account at the end of the business day are "removed" and invested in overnight securities that pay the corporation interest. This innovation is referred to as a A) sweep account. B) share draft account. C) removed-repo account. D) stockman account. Answer: A 39) Sweep accounts which were created to avoid reserve requirements became possible because of a change in ________. A) demand conditions B) supply conditions C) government rules D) bank mergers Answer: B 40) Sweep accounts A) have made reserve requirements nonbonding for many banks. B) sweep funds out of deposit accounts into long-term securities. C) enable banks to avoid paying interest to corporate customers. D) reduce banks' assets. Answer: A 41) Since 1974, commercial banks importance as a source of funds for nonfinancial borrowers A) has shrunk dramatically, from around 40 percent of total credit advanced to below 30 percent by 2005. B) has shrunk dramatically, from around 70 percent of total credit advanced to below 50 percent by 2005. C) has expanded dramatically, from around 50 percent of total credit advanced to above 70 percent by 2005. D) has expanded dramatically, from around 30 percent of total credit advanced to above 50 percent by 2005. Answer: A 42) Thrift institutions importance as a source of funds for borrowers A) has shrunk from around 40 percent of total credit advanced in the late 1970s to below 30 percent by 2005. B) has shrunk from over 20 percent of total credit advanced in the late 1970s to below 6 percent by 2005. C) has expanded dramatically, from around 15 percent of total credit advanced in the late 1970s to above 25 percent by 2005. D) has expanded dramatically, from around 15 percent of total credit advanced in the late 1970s to above 30 percent by 2005. Answer: B 43) Since 1980 A) bank profitability has declined. B) banks have offset the decline in profits from traditional activities with increased income from off-balance-sheet activities. C) banks have offset the decline in profits from off-balance-sheet activities with increased income from traditional activities. D) bank profits have grown rapidly due to deregulation. Answer: B 44) Financial innovation has caused A) banks to suffer declines in their cost advantages in acquiring funds, although it has not caused a decline in income advantages. B) banks to suffer a simultaneous decline of cost and income advantages. C) banks to suffer declines in their income advantages in acquiring funds, although it has not caused a decline in cost advantages. D) banks to achieve competitive advantages in both costs and income. Answer: B 45) Disintermediation resulted from A) interest rate ceilings combine with inflation-driven increases in interest rates. B) elimination of Regulation Q (the regulation imposing interest rate ceilings on bank deposits). C) increases in federal income taxes. D) reserve requirements. Answer: A 46) The experience of disintermediation in the banking industry illustrates that A) more regulation of financial markets may avoid such problems in the future. B) banks are unable to remain competitive with other financial intermediaries. C) consumers no longer desire the services that banks provide. D) markets invent alternatives to costly regulations. Answer: D 47) Banks responded to disintermediation by A) supporting the elimination of interest rate regulations, enabling them to better compete for funds. B) opposing the elimination of interest rate regulations, as this would increase their cost of funds. C) demanding that interest rate regulations be imposed on money market mutual funds. D) supporting the elimination of interest rate regulations, as this would reduce their cost of funds. Answer: A 48) One factor contributing to the decline in cost advantages that banks once had is the A) decline in the importance of checkable deposits from over 60 percent of banks' liabilities to under 10 percent today. B) decline in the importance of savings deposits from over 60 percent of banks' liabilities to under 15 percent today. C) decline in the importance of checkable deposits from over 40 percent of banks' liabilities to under 15 percent today. D) decline in the importance of savings deposits from over 40 percent of banks' liabilities to under 20 percent today. Answer: A 49) The most important developments that have reduced banks cost advantages in the past thirty years include: A) the growth of the junk bond market. B) the competition from money market mutual funds. C) the growth of securitization. D) the growth in the commercial paper market. Answer: B 50) The most important developments that have reduced banks income advantages in the past thirty years include: A) the increase in off-balance sheet activities. B) the growth of securitization. C) the elimination of Regulation Q ceilings. D) the competition from money market mutual funds. Answer: B 51) Banks have attempted to maintain adequate profit levels by A) making fewer riskier loans, such as commercial real estate loans. B) pursuing new off-balance-sheet activities. C) increasing reserve deposits at the Fed. D) decreasing capital accounts.. Answer: B 52) The decline in traditional banking internationally can be attributed to A) increased regulation. B) improved information technology. C) increasing monopoly power of banks over depositors. D) increased protection from competition. Answer: B 53) Why did the interest rate volatibility of the 1970s spur financial innovation? Answer: Banks were very vulnerable to interest-rate risk in the mortgage loans. To protect themselves, banks began to issue adjustable-rate mortgages whose interest rate will increase along with market interest rates. Additionally financial derivatives were developed to help hedge against interest-rate risk. 12.3 Structure of the U.S. Commercial Banking Industry 1) The presence of so many commercial banks in the United States is most likely the result of A) consumers' strong desire for dealing with only local banks. B) adverse selection and moral hazard problems that give local banks a competitive advantage over larger banks. C) prior regulations that restrict the ability of these financial institutions to open branches. D) consumers' preference for state banks. Answer: C 2) The McFadden Act of 1927 A) effectively prohibited banks from branching across state lines. B) required that banks maintain bank capital equal to at least 6 percent of their assets. C) effectively required that banks maintain a correspondent relationship with large money center banks. D) separated the commercial banks and investment banks. Answer: A 3) The legislation that effectively prohibited banks from branching across state lines and forced all national banks to conform to the branching regulations in the state in which they reside is the A) McFadden Act. B) National Bank Act. C) Glass-Steagall Act. D) Garn-St.Germain Act. Answer: A 4) The large number of banks in the United States is an indication of A) vigorous competition within the banking industry. B) lack of competition within the banking industry. C) only efficient banks operating within the United States. D) consumer preference for local banks. Answer: B 5) Lack of competition in the United States banking industry can be attributed to A) the fact that competition does not benefit consumers. B) the fact that branching has eliminated competition. C) recent legislation restricting competition. D) nineteenth-century populist sentiment. Answer: D 6) Which of the following is a true statement concerning bank holding companies? A) Bank holding companies own few large banks. B) Bank holding companies have experienced dramatic growth in the past three decades. C) The McFadden Act has prevented bank holding companies from establishing branch banks. D) Bank holding companies can own only banks. Answer: B 7) A financial innovation that developed as a result of banks avoidance of bank branching restrictions was ________. A) money market mutual funds B) commercial paper C) junk bonds D) bank holding companies Answer: D 8) ATMs were developed because of breakthroughs in technology and as a A) means of avoiding restrictive branching regulations. B) means of avoiding paying interest to corporate customers. C) way of concealing transactions from the SEC. D) increasing the competition from foreign banks. Answer: A 9) What financial innovations helped banks to get around the bank branching restrictions of the McFadden Act? Answer: The introduction of the automated teller machine allowed a bank's customers to have access to funds from various locations not just the bank building and was not subject to the branching restrictions. Bank holding companies could own controlling interest in several banks and other companies related to banking. 12.4 Bank Consolidation and Nationwide Banking 1) The primary reason for the recent reduction in the number of banks is A) bank failures. B) re-regulation of banking. C) restrictions on interstate branching. D) mergers and acquisitions. Answer: D 2) Bank holding companies that rival money center banks in size, but are not located in money center cities are A) superregional banks. B) bank clearing houses. C) international banks. D) local banks. Answer: A 3) The ability to use one resource to provide different products and services is A) economies of scale. B) economies of scope. C) diversification. D) vertical integration. Answer: B 4) The business term for economies of scope is A) economies of scale. B) diversification. C) cooperation. D) synergies. Answer: D 5) The legislation that overturned the prohibition on interstate banking is A) the McFadden Act. B) the Gramm-Leach-Bliley Act. C) the Glass-Steagall Act D) the Riegle-Neal Act Answer: D 6) Although it has a population about half that of the United States, Japan has A) many more banks. B) about 25 percent of the number of banks. C) more than 5000 commercial banks. D) fewer than 100 commercial banks. Answer: D 7) Experts predict that the future structure of the U.S. banking industry will have A) an increased number of banks. B) as few as ten banks. C) several thousand banks. D) a few hundred banks. Answer: C 8) Bank consolidation will likely result in A) less competition. B) the elimination of community banks. C) increased competition. D) a shift in assets from larger banks to smaller banks. Answer: C 9) Critics of nationwide banking fear A) an elimination of community banks. B) increased lending to small businesses. C) cutthroat competition. D) banks with economies of scale problems. Answer: A 10) One of the concerns of increased bank consolidation is the reduction in community banks which could result in A) less lending to small businesses. B) loss of cultural identity. C) higher interest rates. D) more bank regulation. Answer: A 11) Nationwide banking might reduce bank failures due to A) reduced competition. B) reduced lending to small businesses. C) diversification of loan portfolios across state lines. D) elimination of community banks. Answer: C 12) As the banking system in the United States evolves, it is expected that A) the number and importance of small banks will increase. B) the number and importance of large banks will decrease. C) small banks will grow at the expense of large banks. D) the number and importance of large banks will increase. Answer: D 12.5 Separation of the Banking and Other Financial Service Industries 1) The legislation overturning the Glass-Steagall Act is A) the McFadden Act. B) the Gramm-Leach-Bliley Act. C) the Garn-St. Germain Act D) the Riegle-Neal Act. Answer: B 2) Under the Gramm-Leach-Bliley Act states retain regulatory authority over ________. A) bank holding companies B) securities activities C) insurance activities D) bank subsidiaries engaged in securities underwriting Answer: C 3) As a result of the subprime financial crisis several of the large, free-standing investment banking firms chose to become bank holding companies. This means that they will now be regulated by A) the Federal Reserve. B) the FDIC. C) the state banking authorities. D) the Treasury. Answer: A 4) In a ________ banking system, commercial banks provide a full range of banking, securities, and insurance services, all within a single legal entity. A) universal B) severable C) barrier-free D) divider less Answer: A 5) In a ________ banking system, commercial banks engage in securities underwriting, but legal subsidiaries conduct the different activities. Also, banking and insurance are not typically undertaken together in this system. A) universal B) British-style universal C) short-fence D) compartmentalized Answer: B 6) A major difference between the United States and Japanese banking systems is that A) American banks are allowed to hold substantial equity stakes in commercial firms, whereas Japanese banks cannot. B) Japanese banks are allowed to hold substantial equity stakes in commercial firms, whereas American banks cannot. C) bank holding companies are illegal in the United States. D) Japanese banks are usually organized as bank holding companies. Answer: B 12.6 Thrift Industry: Regulation and Structure 1) Like the dual banking system for commercial banks, thrifts can have either ________ or ________ charters. A) state; federal B) state; local C) local; federal D) municipal; federal Answer: A 2) The regulatory agency responsible for supervising savings and loans institutions is the A) FSLIC. B) Fed. C) Comptroller of the Currency. D) Office of Thrift Supervision. Answer: D 3) Unlike banks, ________ have been allowed to branch statewide since 1980. A) federally-chartered S&Ls B) state-chartered S&Ls C) financially troubled S&Ls D) technically insolvent S&Ls Answer: A 4) Thrift institutions include A) commercial banks. B) brokerage firms C) insurance companies. D) mutual savings banks. Answer: D 5) Mutual savings banks are owned by ________. A) shareholders B) partners C) depositors D) foreign investors Answer: C 6) An essential characteristic of credit unions is that A) they are typically large. B) branching across state lines is prohibited. C) their lending is primarily for mortgage loans. D) they are organized for individuals with a common bond. Answer: D 7) ________ are the only depository institutions that are tax-exempt. A) Commercial banks B) Savings and loans C) Mutual savings banks D) Credit unions Answer: D 12.7 International Banking 1) The spectacular growth in international banking can be explained by A) the rapid growth in international trade. B) the 1988 Basel Agreement. C) the desire for U.S. banks to escape burdensome domestic regulations. D) the creation of the World Trade Organization. Answer: A 2) What country is given credit for the birth of the Eurodollar market? A) The United States B) England C) The Soviet Union D) Japan Answer: C 3) Deposits in European banks denominated in dollars for the purpose of international transactions are known as A) Eurodollars. B) European Currency Units. C) European Monetary Units. D) International Monetary Units. Answer: A 4) The main center of the Eurodollar market is A) London. B) Basel. C) Paris. D) New York. Answer: A 5) Eurodollars are A) dollar-dominated deposits held in banks outside the United States. B) deposits held by U.S. banks in Europe. C) deposits held by U.S. banks in foreign countries. D) dollar-dominated deposits held in U.S. banks by Europeans. Answer: A 6) Reasons for holding Eurodollars include A) the fact that Eurodollar deposits are insured by the FDIC. B) the fact that dollars are widely used to conduct international transactions. C) the fact that minimum transaction sizes are very low, making Eurodollars an attractive savings instrument for consumers. D) the fact that Eurodollar deposits are heavily regulated. Answer: B 7) An advantage to American banks from operating foreign branches is that Eurodollar deposits in offshore branches are A) not subject to reserve requirements. B) insured by the FDIC. C) subject to extensive regulatory supervision. D) all demand deposits that pay no interest. Answer: A 8) U.S. banks have most of their branches in A) Latin America, the Far East, the Caribbean, and London. B) Latin America, the Middle East, the Caribbean, and London. C) Mexico, the Middle East, the Caribbean, and London. D) South America, the Middle East, the Caribbean, and Canada. Answer: A 9) A ________ is a subsidiary of a U.S. bank that is engaged primarily in international banking. A) Edge Act corporation B) Eurodollar agency C) universal bank D) McFadden corporation Answer: A 10) ________ within the U.S. can make loans to foreigners but cannot make loans to domestic residents. A) Edge Act corporations B) International Banking Facilities C) Universal banks D) Euro banks Answer: B 11) ________ of a foreign bank operates in the U.S. but cannot accept deposits from domestic residents. A) An agency office B) A universal corporation C) A McFadden corporation D) A Basel branch Answer: A 12) If a foreign bank operates a subsidiary bank in the U.S., the subsidiary bank is A) subject to the same regulations as a U.S. owned bank. B) only subject to the regulations of the country in which the foreign bank is chartered. C) restricted to making loans to only foreign citizens in the U.S. D) restricted to accepting deposits from foreign citizens living in the U.S. Answer: A 13) Since the passage of the International Banking Act of 1978, the competitive advantage enjoyed by foreign banks in the U.S. has been A) reduced. B) mildly expanded. C) completely eliminated. D) greatly expanded. Answer: A 14) Discuss three ways in which U.S. banks can become involved in international banking. Answer: United States banks could open a foreign branch of their bank. A U.S. bank holding company could purchase controlling interest in a foreign bank in a foreign country. A U.S. bank could open a Edge Act Corporation. A U.S. bank could open an International Banking Facility in the U.S. which accepts time deposits from foreigners and makes loans to foreigners in the U.S. Chapter 13 Central Banks and the Federal Reserve System 13.1 The Price Stability Goal and The Nominal Anchor 1) The most common definition that monetary policymakers use for price stability is A) low and stable deflation. B) an inflation rate of zero percent. C) high and stable inflation. D) low and stable inflation. Answer: D 2) Price stability is desirable because A) inflation creates uncertainty, making it difficult to plan for the future. B) everyone is better off when prices are stable. C) price stability increases the profitability of the Fed. D) it guarantees full employment. Answer: A 3) Inflation results in A) ease of planning for the future. B) ease of comparing prices over time. C) lower nominal interest rates. D) difficulty interpreting relative price movements. Answer: D 4) Economists believe that countries recently suffering hyperinflation have experienced A) reduced growth. B) increased growth. C) reduced prices. D) lower interest rates. Answer: A 5) A nominal variable, such as the inflation rate or the money supply, which ties down the price level to achieve price stability is called ________ anchor. A) a nominal B) a real C) an operating D) an intermediate Answer: A 6) A central feature of monetary policy strategies in all countries is the use of a nominal variable that monetary policymakers use as an intermediate target to achieve an ultimate goal such as price stability. Such a variable is called a nominal A) anchor. B) benchmark. C) tether. D) guideline. Answer: A 7) A central feature of monetary policy strategies in all countries is the use of a nominal anchor, which is a nominal variable that monetary policymakers use as an A) operating target, such as the federal funds interest rate. B) intermediate target, such as the federal funds interest rate. C) intermediate target to achieve an ultimate goal such as price stability. D) operating target to achieve an ultimate goal such as exchange rate stability. Answer: C 8) A nominal anchor promotes price stability by A) outlawing inflation. B) stabilizing interest rates. C) keeping inflation expectations low. D) keeping economic growth low. Answer: C 9) Monetary policy is considered time-inconsistent because A) of the lag times associated with the implementation of monetary policy and its effect on the economy. B) policymakers are tempted to pursue discretionary policy that is more contractionary in the short run. C) policymakers are tempted to pursue discretionary policy that is more expansionary in the short run. D) of the lag times associated with the recognition of a potential economic problem and the implementation of monetary policy. Answer: C 10) The time-inconsistency problem with monetary policy tells us that, if policymakers use discretionary policy, there is a higher probability that the ________ will be higher, compared to policy makers following a behavior rule. A) inflation rate B) unemployment rate C) interest rate D) foreign exchange rate Answer: A 11) 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) adverse selection problem. B) moral hazard problem. C) time-inconsistency problem. D) nominal-anchor problem. Answer: C 12) The ________ problem of discretionary policy arises because economic behavior is influenced by what firms and people expect the monetary authorities to do in the future. A) moral hazard B) time-inconsistency C) nominal-anchor D) rational-expectation Answer: B 13) If the central bank pursues a monetary policy that is more expansionary than what firms and people expect, then the central bank must be trying to A) boost output in the short run. B) constrain output in the short run. C) constrain prices. D) boost prices in the short run. Answer: A 14) The time-inconsistency problem in monetary policy can occur when the central bank conducts policy A) using a nominal anchor. B) using a strict and inflexible rule. C) on a discretionary, day-by-day basis. D) using a flexible, discretionary rule. Answer: C 15) Explain the time-inconsistency problem. What is the likely outcome of discretionary policy? What are the solutions to the time-inconsistency problem? Answer: With policy discretion, policymakers have an incentive to attempt to increase output by pursuing expansionary policies once expectations are set. The problem is that this policy results not in higher output, but in higher actual and expected inflation. The solution is to adopt a rule to constrain discretion. Nominal anchors can provide the necessary constraint on discretionary behavior. 13.2 Other Goals of Monetary Policy 1) Even if the Fed could completely control the money supply, monetary policy would have critics because A) the Fed is asked to achieve many goals, some of which are incompatible with others. B) the Fed's goals do not include high employment, making labor unions a critic of the Fed. C) the Fed's primary goal is exchange rate stability, causing it to ignore domestic economic conditions. D) it is required to keep Treasury security prices high. Answer: A 2) High unemployment is undesirable because it A) results in a loss of output. B) always increases inflation. C) always increases interest rates. D) reduces idle resources. Answer: A 3) When workers voluntarily leave work while they look for better jobs, the resulting unemployment is called A) structural unemployment. B) frictional unemployment. C) cyclical unemployment. D) underemployment. Answer: B 4) Unemployment resulting from a mismatch of workers' skills and job requirements is called A) frictional unemployment. B) structural unemployment. C) seasonal unemployment. D) cyclical unemployment. Answer: B 5) The goal for high employment should be a level of unemployment at which the demand for labor equals the supply of labor. Economists call this level of unemployment the A) frictional level of unemployment. B) structural level of unemployment. C) natural rate level of unemployment. D) Keynesian rate level of unemployment. Answer: C 6) Supply-side economic policies seek to A) raise interest rates through contractionary monetary policy. B) increase federal government expenditures. C) increase consumption expenditures by increasing taxes. D) increase saving and investment using tax incentives. Answer: D 7) The Federal Reserve System was created to A) make it easier to finance budget deficits. B) promote financial market stability. C) lower the unemployment rate. D) promote rapid economic growth. Answer: B 8) Having interest rate stability A) allows for less uncertainty about future planning. B) leads to demands to curtail the Fed's power. C) guarantees full employment. D) leads to problems in financial markets. Answer: A 9) Foreign exchange rate stability is important because a decline in the value of the domestic currency will ________ the inflation rate, and an increase in the value of the domestic currency makes domestic industries ________ competitive with competing foreign industries. A) increase; more B) increase; less C) decrease; more D) decrease; less Answer: B 13.3 Should Price Stability be the Primary Goal of Monetary Policy? 1) Which set of goals can, at times, conflict in the short run? A) High employment and economic growth. B) Interest rate stability and financial market stability. C) High employment and price level stability. D) Exchange rate stability and financial market stability. Answer: C 2) The primary goal of the European Central Bank is A) price stability. B) exchange rate stability. C) interest rate stability. D) high employment. Answer: A 3) The mandate for the monetary policy goals that has been given to the European Central Bank is an example of a ________ mandate. A) primary B) dual C) secondary D) hierarchical Answer: D 4) The mandate for the monetary policy goals that has been given to the Federal Reserve System is an example of a ________ mandate. A) primary B) dual C) secondary D) hierarchical Answer: B 5) Either a dual or hierarchial mandate is acceptable as long as ________ is the primary goal in the ________. A) price stability; short run B) price stability; long run C) reducing business-cycle fluctuations; short run D) reducing business-cycle fluctuations; long run Answer: B 13.4 Origins of the Federal Reserve System 1) The First Bank of the United States A) was disbanded in 1811 when its charter was not renewed. B) had its charter renewal vetoed in 1832. C) was fundamental in helping the Federal Government finance the War of 1812. D) None of the above. Answer: A 2) The Second Bank of the United States A) was disbanded in 1811 when its charter was not renewed. B) had its charter renewal vetoed in 1832. C) is considered to be the primary cause of the bank panic of 1907. D) None of the above. Answer: B 3) The public's fear of centralized power and distrust of moneyed interests led to the demise of the first two experiments in central banking: A) the First Bank of the United States and the Second Bank of the United States. B) the First Bank of the United States and the Central Bank of the United States. C) the First Central Bank of the United States and the Second Central Bank of the United States. D) the First Bank of North America and the Second Bank of North America. Answer: A 4) The financial panic of 1907 resulted in such widespread bank failures and substantial losses to depositors that the American public finally became convinced that A) the First Bank of the United States had failed to serve as a lender of last resort. B) the Second Bank of the United States had failed to serve as a lender of last resort. C) the Federal Reserve System had failed to serve as a lender of last resort. D) a central bank was needed to prevent future panics. Answer: D 5) What makes the Federal Reserve so unique compared to other central banks around the world is its A) centralized structure. B) decentralized structure. C) regulatory functions. D) monetary policy functions. Answer: B 13.5 Structure of the Federal Reserve System 1) Which of the following is NOT an entity of the Federal Reserve System? A) Federal Reserve Banks B) The Comptroller of the Currency C) The Board of Governors D) The Federal Open Market Committee Answer: B 2) Which of the following is an entity of the Federal Reserve System? A) The U.S. Treasury Secretary B) The FOMC C) The Comptroller of the Currency D) The FDIC Answer: B 3) The three largest Federal Reserve banks (New York, Chicago, and San Francisco) combined hold more than ________ percent of the assets of the Federal Reserve System. A) 25 B) 33 C) 50 D) 67 Answer: C 4) The Federal Reserve Banks are ________ institutions since they are owned by the ________. A) quasi-public; private commercial banks in the district where the Reserve Bank is located B) public; private commercial banks in the district where the Reserve Bank is located C) quasi-public; Board of Governors D) public; Board of Governors Answer: A 5) Each Federal Reserve bank has nine directors. Of these ________ are appointed by the member banks and ________ are appointed by the Board of Governors. A) three; six B) four; five C) five; four D) six; three Answer: D 6) The nine directors of the Federal Reserve Banks are split into three categories: ________ are professional bankers, ________ are leaders from industry, and ________ are to represent the public interest and are not allowed to be officers, employees, or stockholders of banks. A) 5; 2; 2 B) 2; 5; 2 C) 4; 2; 3 D) 3; 3; 3 Answer: D 7) Member commercial banks have purchased stock in their district Fed banks; the dividend paid by that stock is limited by law to ________ percent annually. A) four B) five C) six D) eight Answer: C 8) The Federal Reserve Bank of ________ plays a special role in the Federal Reserve System because it houses the open market desk. A) Boston B) New York C) Chicago D) San Francisco Answer: B 9) The president from which Federal Reserve Bank always has a vote in the Federal Open Market Committee? A) Philadelphia B) Boston C) San Francisco D) New York Answer: D 10) An important function of the regional Federal Reserve Banks is A) setting reserve requirements. B) clearing checks. C) determining monetary policy. D) setting margin requirements. Answer: B 11) Which of the following functions are not performed by any of the twelve regional Federal Reserve Banks? A) Check clearing B) Conducting economic research C) Setting interest rates payable on time deposits D) Issuing new currency Answer: C 12) All ________ are required to be members of the Fed. A) state chartered banks B) nationally chartered banks C) banks with assets less than $100 million D) banks with assets less than $500 million Answer: B 13) Of all commercial banks, about ________ percent belong to the Federal Reserve System. A) 17 B) 22 C) 37 D) 52 Answer: C 14) Prior to 1980, member banks left the Federal Reserve System due to A) the high cost of discount loans. B) the high cost of required reserves. C) a desire to avoid interest rate regulations. D) a desire to avoid credit controls. Answer: B 15) The Fed's support of the Depository Institutions Deregulation and Monetary Control Act of 1980 stemmed in part from its A) concern over declining Fed membership. B) belief that all banking regulations should be eliminated. C) belief that interest rate ceilings were too high. D) belief that depositors had to become more knowledgeable of banking operations. Answer: A 16) Banks subject to reserve requirements set by the Federal Reserve System include A) only nationally chartered banks. B) only banks with assets less than $100 million. C) only banks with assets less than $500 million. D) all banks whether or not they are members of the Federal Reserve System. Answer: D 17) The Depository Institutions Deregulation and Monetary Control Act of 1980 A) established higher reserve requirements for non member than for member banks. B) established higher reserve requirements for member than for non member banks. C) abolished reserve requirements. D) established uniform reserve requirements for all banks. Answer: D 18) There are ________ members of the Board of Governors of the Federal Reserve System. A) 5 B) 7 C) 12 D) 19 Answer: B 19) Members of the Board of Governors are A) chosen by the Federal Reserve Bank presidents. B) appointed by the newly elected president of the United States, as are cabinet positions. C) appointed by the president of the United States and confirmed by the Senate as members resign. D) never allowed to serve more than 7-year terms. Answer: C 20) Each governor on the Board of Governors can serve A) only one non renewable fourteen-year term. B) one full non renewable fourteen-year term plus part of another term. C) only one non renewable eight-year term. D) one full non renewable eight-year term plus part of another term. Answer: B 21) The Chairman of the Board of Governors is chosen from among the seven governors and serves a ________ term. A) one-year B) two-year C) four-year D) eight-year Answer: C 22) While the discount rate is "established" by the regional Federal Reserve Banks, in truth, the rate is determined by A) Congress. B) the president of the United States. C) the Senate. D) the Board of Governors. Answer: D 23) Which of the following are duties of the Board of Governors of the Federal Reserve System? A) Setting margin requirements, the fraction of the purchase price of the securities that has to be paid for with cash. B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q. C) Regulating credit with the approval of the president under the Credit Control Act of 1969. D) All governors advise the president of the United States on economics policy. Answer: A 24) Which of the following are not current duties of the Board of Governors of the Federal Reserve System? A) Setting margin requirements, the fraction of the purchase price of the securities that has to be paid for with cash. B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q. C) Approving the discount rate "established" by the Federal Reserve banks. D) Representing the United States in negotiations with foreign governments on economic matters. Answer: B 25) The Federal Open Market Committee usually meets ________ times a year. A) four B) six C) eight D) twelve Answer: C 26) The Federal Reserve entity that makes decisions regarding the conduct of open market operations is the A) Board of Governors. B) chairman of the Board of Governors. C) Federal Open Market Committee. D) Open Market Advisory Council Answer: C 27) The Federal Open Market Committee consists of the A) five senior members of the seven-member Board of Governors. B) seven members of the Board of Governors and seven presidents of the regional Fed banks. C) seven members of the Board of Governors and five presidents of the regional Fed banks. D) twelve regional Fed bank presidents and the chairman of the Board of Governors. Answer: C 28) The majority of members of the Federal Open Market Committee are A) Federal Reserve Bank presidents. B) members of the Federal Advisory Council. C) presidents of member banks. D) the seven Federal Reserve governors. Answer: D 29) Each Fed bank president attends FOMC meetings; although only ________ Fed bank presidents vote on policy, all ________ provide input. A) three; ten B) five; ten C) three; twelve D) five; twelve Answer: D 30) Although neither ________ nor the ________ are officially set by the Federal Open Market Committee, decisions concerning these policy tools are effectively made by the committee. A) margin requirements; discount rate B) margin requirements; federal funds rate C) reserve requirements; discount rate D) reserve requirements; federal funds rate Answer: C 31) The research document given to the Federal Open Market Committee that contains information on the state of the economy in each Federal Reserve district is called the A) beige book. B) green book. C) blue book. D) black book. Answer: A 32) The research document given to the Federal Open Market Committee that contains the forecast of national economic variables for the next two years is called the A) beige book. B) green book. C) blue book. D) black book. Answer: B 33) The research document given to the Federal Open Market Committee that contains forecasts of the money aggregates conditional on different monetary policy stances is called the A) beige book. B) green book. C) blue book. D) black book. Answer: C 34) The Federal Open Market Committee's "balance of risks" is an assessment of whether, in the future, its primary concern will be A) higher exchange rates or higher unemployment. B) higher inflation or a stronger economy. C) higher inflation or a weaker economy. D) lower inflation or a stronger economy. Answer: C 35) Why does the Federal Reserve Bank of New York play a special role within the Federal Reserve System? Answer: The New York district contains the largest banks in the country. The New York Fed supervises and examines these banks to insure their soundness and the safety of the nation's financial system. The New York Fed conducts open market operations and foreign exchange transactions for the Fed and Treasury. The New York Fed belongs to the Bank for International Settlements, so its president and the chairman of the Board of Governors represent the U.S. at the monthly meetings of the world's central banks. The New York Fed president is the only president of a regional Fed who is a permanent voting member of the FOMC. 36) Who are the voting members of the Federal Open Market Committee and why is this committee important? Where does the power lie within this committee? Answer: The FOMC determines the monetary policy of the United States through its decisions about open market operations. It also effectively determines the discount rate and reserve requirements. The seven members of the Board of Governors, the president of the New York Fed, and four of the other eleven regional bank presidents are voting members on a rotating basis. Within the FOMC, the chairman of the Board of Governors wields the power. 13.6 How Independent is the Fed? 1) Instrument independence is the ability of ________ to set monetary policy ________. A) the central bank; goals B) Congress; goals C) Congress; instruments D) the central bank; instruments Answer: D 2) The ability of a central bank to set monetary policy instruments is A) political independence. B) goal independence. C) policy independence. D) instrument independence. Answer: D 3) Goal independence is the ability of ________ to set monetary policy ________. A) the central bank; goals B) Congress; goals C) Congress; instruments D) the central bank; instruments Answer: A 4) The ability of a central bank to set monetary policy goals is A) political independence. B) goal independence. C) policy independence. D) instrument independence. Answer: B 5) Members of Congress are able to influence monetary policy, albeit indirectly, through their ability to A) withhold appropriations from the Board of Governors. B) withhold appropriations from the Federal Open Market Committee. C) propose legislation that would force the Fed to submit budget requests to Congress, as must other government agencies. D) instruct the General Accounting Office to audit the foreign exchange market functions of the Federal Reserve. Answer: C 6) Explain two concepts of central bank independence. Is the Fed politically independent? Why do economists think central bank independence is important? Answer: Instrument independence is the ability of the central bank to set its instruments, and goal independence is the ability of a central bank to set its goals. The Fed enjoys both types of independence. The Fed is largely independent of political pressure due to its earnings and the conditions of appointment of the Board of Governors and its chairman. However, some political pressure can be applied through the threat or enactment of legislation affecting the Fed. Independence is important because there is some evidence that independent central banks pursue lower rates of inflation without harming overall economic performance. 13.7 Structure and Independence of the European Central Bank 1) Under the European System of Central Banks, the Executive Board is similar in structure to the ________ of the Federal Reserve System. A) Board of Governors B) Federal Open Market Committee C) Federal Reserve Banks D) Federal Advisory Council Answer: A 2) Under the European System of Central Banks, the Governing Council is similar in structure to the ________ of the Federal Reserve System. A) Board of Governors B) Federal Open Market Committee C) Federal Reserve Banks D) Federal Advisory Council Answer: B 3) Under the European System of Central Banks, the National Central Banks have the same role as the ________ of the Federal Reserve System. A) Board of Governors B) Federal Open Market Committee C) Federal Reserve Banks D) Federal Advisory Council Answer: C 4) Members of the Executive Board of the European System of Central Banks are appointed to ________ year, non renewable terms. A) four B) eight C) ten D) fourteen Answer: B 5) Which of the following statements comparing the European System of Central Banks and the Federal Reserve System is TRUE? A) The budgets of the Federal Reserve Banks are controlled by the Board of Governors, while the National Central Banks control their own budgets and the budget of the European Central Bank. B) The European Central Bank has similar power over the National Central Banks when compared to the level of power the Board of Governors has over the Federal Reserve Banks. C) Just like the Federal Reserve System, monetary operations are centralized in the European System of Central Banks with the European Central Bank. D) The European Central Bank's involvement in supervision and regulation of financial institutions is comparable to the Board of Governors' involvement. Answer: A 6) The Governing Council usually meets ________ times a year. A) four B) six C) eight D) twelve Answer: D 7) In the Governing Council, the decision of what policy to implement is made by A) majority vote of the Executive Board members. B) majority vote of the heads of the National Banks. C) consensus. D) majority vote of all members of the Governing Council. Answer: C 8) As of the beginning of the year 2009, there are ________ countries that have representation on the Governing Council. A) six B) eight C) ten D) twelve Answer: D 9) The central bank which is generally regarded as the most independent in the world because its charter cannot be changed by legislation is the A) Bank of England. B) Bank of Canada. C) European Central Bank. D) Bank of Japan. Answer: C 10) Explain the similarities and differences between the European System of Central Banks and the Federal Reserve System. Answer: The similarities between the two are in their structure. The National Central Banks of the member countries of the Euro system have the same role as the Federal Reserve Banks in the Federal Reserve system. The Executive Board and the Governing Council of the Euro system resemble the Board of Governors and the Federal Open Market Committee of the Federal Reserve System, respectively. There are three major differences between the two. The first difference is concerning the control of the budgets. In the Fed, the Board of Governors controls the budgets of the Reserve Banks while in the Euro system, the National Banks control the budget of the European Central Bank. The second difference is the monetary operations of the Euro system are conducted by the National Banks, so they are not as centralized as the monetary operations in the Federal Reserve System. Finally, the European Central Bank is not involved in the supervision and regulation of the financial institutions in the euro zone while the Federal Reserve is involved with the regulation and supervision of the financial institutions in the United States. 13.8 Structure and Independence of Other Foreign Central Banks 1) On paper, the Bank of Canada has ________ instrument independence and ________ goal independence when compared to the Federal Reserve System. A) less; less B) less; more C) more; less D) more; more Answer: A 2) The oldest central bank, having been founded in 1694, is the A) Bank of England. B) Deutsche Bundesbank. C) Bank of Japan. D) Federal Reserve System. Answer: A 3) While legislation enacted in 1998 granted the Bank of Japan new powers and greater autonomy, its critics contend that its independence is A) limited by the Ministry of Finance's veto power over a portion of its budget. B) too great because it need not pursue a policy of price stability even if that is the popular will of the people. C) too great since the Ministry of Finance no longer has veto power over the bank's budget. D) limited since the Ministry of Finance can dismiss senior bank officials. Answer: A 4) Regarding central bank independence, A) the Fed is more independent than the European Central Bank. B) the European Central Bank is more independent than the Fed. C) the trend in industrialized nations has been to reduce central bank independence. D) the Bank of England has the longest tradition of independence of any central bank in the world. Answer: B 5) The trend in recent years is that more and more governments A) have been granting greater independence to their central banks. B) have been reducing the independence of their central banks to make them more accountable for poor economic performance. C) have mandated that their central banks focus on controlling inflation. D) have required their central banks to cooperate more with their Ministers of Finance. Answer: A 6) Which of the following statements about central bank structure and independence are true? A) In recent years, with the exception of the Bank of England and the Bank of Japan, most countries have reduced the independence of their central banks, subjecting them to greater democratic control. B) Before the Bank of England was granted greater independence, the Federal Reserve was the most independent of the world's central banks. C) Both theory and experience suggest that more independent central banks produce better monetary policy. D) While the European Central Bank is independent, it is not as independent as the Federal Reserve. Answer: C 13.9 Explaining Central Bank Behavior 1) The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximize A) the public's welfare. B) profits. C) its own welfare. D) conflict with the executive and legislative branches of government. Answer: C 2) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed A) is supportive of congressional attempts to limit the central bank's autonomy. B) is so secretive about the conduct of future monetary policy. C) sought less control over banks in the 1980s. D) is willing to take on powerful groups that may threaten its autonomy. Answer: B 3) Compared to the Federal Reserve, the European Central Bank is less transparent because A) the European Central Bank doesn't publicly release its inflation rate target for the European Monetary Union while the Federal Reserve publicly releases its inflation rate target for the United States. B) the Federal Reserve holds a press conference after a policy meeting while the European Central Bank makes no public statement after its policy meetings. C) the Federal Reserve publicly releases the minutes 3 weeks after the meetings while the European Central bank waits 20 years to publicly release its minutes. D) the European Central Bank does not publicly release its economic forecasts while the Federal Reserve immediately releases its economic forecasts to the public. Answer: C 4) What is the theory of bureaucratic behavior and how can it be used to explain the behavior of the Federal Reserve? Answer: The theory of bureaucratic behavior concludes that the main objective of any bureaucracy is to maximize its own welfare, which is related to power and prestige. This can explain why the Federal Reserve has defended its autonomy, avoids conflict with Congress and the president, and its push to gain more control over banks. 13.10 Should the Fed be Independent? 1) The case for Federal Reserve independence does not include the idea that A) political pressure would impart an inflationary bias to monetary policy. B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. C) policy is always performed better by an elite group such as the Fed. D) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced. Answer: C 2) The political business cycle refers to the phenomenon that just before elections, politicians enact ________ policies. After the elections, the bad effects of these policies (for example, ________ ) have to be counteracted with ________ policies. A) expansionary; higher unemployment; contractionary B) expansionary; a higher inflation rate; contractionary C) contractionary; higher unemployment; expansionary D) contractionary; a higher inflation rate; expansionary Answer: B 3) The strongest argument for an independent Federal Reserve rests on the view that subjecting the Fed to more political pressures would impart A) an inflationary bias to monetary policy. B) a deflationary bias to monetary policy. C) a disinflationary bias to monetary policy. D) a countercyclical bias to monetary policy. Answer: A 4) Critics of the current system of Fed independence contend that A) the current system is undemocratic. B) voters have too much say about monetary policy. C) the president has too much control over monetary policy on a day-to-day basis. D) the Board of Governors is held responsible for policy missteps. Answer: A 5) Recent research indicates that inflation performance (low inflation) has been found to be best in countries with A) the most independent central banks. B) political control of monetary policy. C) money financing of budget deficits. D) a policy of always keeping interest rates low. Answer: A 6) Make the case for and against an independent Federal Reserve. Answer: Case for: 1. An independent Federal Reserve can shield the economy from the political business cycle, and it will be less likely to have an inflationary bias to monetary policy. 2. Control of the money supply is too important to leave to inexperienced politicians. Case against: 1. It is undemocratic to have monetary policy be controlled by a small number of individuals that are not accountable. 2. In the past, an independent Fed has not used its freedom wisely. 3. Its independence may encourage it to pursue its own self-interest rather than the public's interest. Test Bank for The Economics of Money, Banking and Financial Markets Frederic S. Mishkin 9780321599797, 9780134734200, 9780133836790, 9780134734606, 9780134733821
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