Question

1. In cases where the markets are too thin for viable open-market operations, or the monetary base cannot be controlled for some reason, the monetary authorities often attempt to limit the creation of reserves by the banking system through the imposition of, or changes in, reserve ratios against demand deposits and sometimes also against other types of deposits.

Select one:

True

False

2. In the United States, the discount rate is frequently below the market short interest rates; since banks can make a profit from borrowing from the Fed and then buying market instruments, keeping the discount rate below the market rates becomes an incentive for commercial banks to borrow from the Fed.

Select one:

True

False

3. Since the early 1990s, the most common tools of monetary policy in developed economies have been changes in interest rates, supported by changes in the money supply induced by open-market operations and borrowing from the central bank.

Select one:

True

False

4. In the Western economies, changes in the required reserve ratios are now either no longer available as an instrument of monetary policy or not used in practice for this purpose.

Select one:

True

False

Answer 1

1. True.

It is important for the health of the economy that the money supply be carefully monitored. A central bank might want to increase or decrease money supply based on market situation. It usually does this on the basis of open market operations- sale or buy of securities in the ope market. But, as the question states, when the markets are too thin for such an operation, Reserve requirements become a very important tool for the governments and central banks to control money supply.

2. True.

Since the discount rate is below the market short rate, its a simple opportunity for the bank to borrow funds from the fed at a lower rate and buy market instruments from them. So the discount rate being lower incentivizes the banks to borrow from Fed.

3. True.

This is simply a fact. Most western countries have reserve requirements of almost zero now. Since the reserve requirement is zero, it can't be used as a tool of monetary policy. This leaves the bank with changes in interest rate and open market operations as tools of monetary policy.

4. True.

See part 3. The reserve requirements are almost zero in most of the western countries, and so this tool can't be used for monetary policy.