Microsoft Word - Money, Banking, and Int Finance(scribd).docx

Money, Banking, and International Finance

government cannot balance its budget, and investors do not want to invest in Greek bonds.

Public believes if the Greek government reintroduces the drachma, then the government will

devalue as it creates money to cover budget deficits. Consequently, the Greek citizens

started a run on the banks to withdraw their savings in euros before the Greek government

converts currency to drachmas.

9. The Executive Board implements monetary policy, while the Governing Council determines
   monetary policy.


10. Euro reduces exchange rate risk, reduces transaction costs, and promotes competition within
    the Eurozone. However, an EU country loses control of its monetary policy. Moreover, the
    prices are high relative to incomes in southern Europe, and the European Central Bank is
    prohibited to help EU countries, such as buying a country’s bonds.


11. Public interest view is a government agency actually solves a problem that it was created to
    solve. Principal-agent view is a bureaucracy serves its own self-interest and may not perform
    the actions a government created it for.


12. Countries with independent central banks usually have very low inflation rates.

Answers to Chapter 14 Questions.........................................................

1. The Fed creates a higher demand in the bond market. Thus, the bond's market price rises
   while the interest rate falls. The Fed injected reserves into the banking system, expanding
   the money supply.


2. The Fed increases the supply in the bond market. Thus, the bond's price falls while the
   interest rate rises. The Fed removed reserves from the banking system, contracting the
   money supply.


3. If the Fed increases the money supply by 3%, it must buy enough U.S. Treasury securities to
   achieve this goal. However, the Fed buying the securities from the bond market decreases
   the interest rate. If the Fed concentrated on the interest rate, it must buy or sell bonds to
   achieve the target interest rate. Nevertheless, the buying or selling of bonds changes the
   bank reserves, and hence, the money supply.


4. A REPO is a repurchase agreement. The Fed temporarily buys a U.S. government security,
   and the seller will buy it back on a specific date in the future. A reserve REPO is the Fed
   sells a U.S. government security and agrees to repurchase it on a particular date in the future.
   REPOS inject reserves into the banking system while reverse REPOs remove reserves
   temporarily.