Question

1. Classify each of these transactions as an asset, a liability, or neither for each of the “players” in the money supply process – the Federal Reserve, the banking system, and nonbank public.

a) You take a $10,000 loan from Bank One to buy an automobile

b) You deposit $400 into your checking account at the First National Bank of Huntsville

c) The Fed provides an emergency loan to a bank for $ 1 million

d) A bank borrows $500,000 in overnight loans from another bank

e) You use your debit card to purchase a meal at a restaurant for $50

2. Suppose that Mr. Justin Bieber deposits $5,000 in his checking account at Santa Monica Bank. How does this transaction affect the monetary base? Show the changes in the balance sheets for Mr. Bieber, the bank, and the Fed.

3. What are the major differences between a discount loan and an open market purchase with respect to their respective effects on monetary base? Explain using an example and showing the relevant changes in the balance sheets of the Fed and the Banking System. Between these two actions, is one preferred to the other by the Fed? Why or why not?

4. As the bankers’ bank, the Federal Reserve Banks operate the payments system in the United States? What are the different components of the payments system that they operate? Briefly describe.

5. What are the main arguments against central bank independence? Is the Fed independent? How do you know? Explain.

Answer 1

Answers 1 (a) - You take $10,000 loan from bank to buy an automobile. It is a loan for nonbank public and asset for bank. Bank will earn interest on this loan in the future.

(b) You deposit $400 into your checking account at the first national bank of Huntsville. This is a liability for bank. It is asset for individual.

(c) The Federal Reserve provides emergency loan to a bank for 1 million. This loan to a bank will be a liability but it an asset for Federal Reserve Bank. FED will earn interest on it in future. The bank will have to pay this loan to the FED.

(d) A bank borrows$500,000 in overnight loans from another bank. This transaction would be recorded as liability for borrower bank and assets for lender bank. Lender bank will earn interest income in future.

(e) You use your debit card to purchase a meal at a restaurant for $50. I used my money for payment. This is neither a liability not asset. This was the simple transaction where i paid my bill from past savings.