The Role of the Federal Reserve in the U.S. Economy
Check Your Knowledge
The mission of a central bank includes promoting macroeconomic stability. Select the option below that best describes “macroeconomic stability.”
A. Macroeconomic stability is characterized by low and stable inflation with stable growth in output and employment. B. Macroeconomic stability is characterized by no financial panics or crises in a nation’s financial system. C. Macroeconomic stability ensures that if a bank fails, depositors will receive full compensation for their losses.
The mission of a central bank includes promoting financial stability. Select the option below that best describes “financial stability.”
A. Financial stability provides low and stable inflation with stable growth in output and employment. B. Financial stability refers to the proper functioning of the financial system. To achieve this, central banks try to prevent or mitigate panics in a country’s financial institutions. C. Financial stability requires a central bank to set consistent, low interest rates for a nation’s financial institutions.
Which of the following best describes monetary policy in normal times?
A. Monetary policy promotes financial stability by setting the amount banks can borrow from the Fed in its role as the “lender of last resort.” B. Monetary policy involves the adjustment of short-term interest rates to promote macroeconomic stability. C. Monetary policy requires that banks maintain enough cash on hand to cover all of their deposits.
Which of the following best describes the provision of liquidity tool of central banks?
A. A central bank requires banks to maintain a certain amount of “liquid assets,” or cash on hand, to reduce the possibility of bank runs and financial panics. B. A central bank sets short-term interest rates for a nation’s financial institutions. C. A central bank provides short-term loans to financial institutions or markets, which can help calm financial panics.
What is the goal of a central bank when it raises short-term interest rates?
A. Raising interest rates encourages banks to loan money, which encourages spending and investment by households and businesses. B. Raising interest rates allows banks to borrow money from the Fed at favorable rates, which can reduce the likelihood of a financial panic. C. Raising interest rates can slow an economy that is growing at an unsustainable pace, which can cause a high rate of inflation.
What did Walter Bagehot believe was the best way for a central bank to respond to a financial panic?
A. Central banks should lend freely against good assets, but at a penalty interest rate to discourage excessive use of the central bank as lender of last resort. B. A central bank should lend only to banks whose investors are likely to retain their deposits in the institution. C. A central bank should raise interest rates during financial panics to stimulate investments in banks and, by extension, the nation’s economy.