Question

1) Describe the asset-liability time mismatch that all banks face.

2) Suppose that, in response to the threat of inflation, the Federal reserve bank runs contractionary policy. (2 points)

a)Will the Federal Reserve bank buy or sell treasuries to/from commercial banks? Explain.

b)What is the effect of this policy on the money supply? Explain.

c)What is the effect of this policy on interest rates? Explain.

d)What is the effect on this policy on aggregate demand? Explain.

Answer 1

1) The primary functions of the bank are to accepting deposit money from the public and lending money to the needy people.The bank rises th fund from the public and lends fund to the people for longer durations this leads to asset-liability mismatches.

Example bank lends $10 Million to the long-term loan to the persons and same $10 Million has to repay to the depositors.

2) During inflation time Federal Reserve adopt the contractionary monetary policy to reduce inflation in the economy

a) The commercial bank required to buy these securities and lending capacity of commercial bank reduces

b) The money supply reduced because funds in the commercial banks reduced and it is difficult to lend money to investors.

c) The interset rises due to central bank policies.and hence the demand for investment will be reduced.

d) The main objectives of the contractionary monetary policies to reduce excessive aggregate demand in the economy by reducing the supply of the money in the economy.