Question

5. Of the three monetary policy tools mentioned in the text, which one does not change the cost of borrowing reserves for commercial banks? 6. What is the relationship between risk and the size of an insurance premium? Why is this relationship "fair" or "logical”? 7. What backs the U.S. money supply? Explain.

Answer 1

5.

It is the required reserve ratio as a monetary policy tool, that does not change the cost of borrowing for commercial banks. It happens, because it eases out the reserve requirements at the bank itself. A lower required reserve ratio, increases the funds available and it requires bank to borrow lesser amount of funds from another bank. Further, changing required reserve does not change the federal fund rate that is the rate of borrowing between the two commercial banks. Hence, it is the required reserve ratio as a tool that does not affect the cost of borrowing.

6.

There is a positive and causal relationship between risk and size of the insurance premium. A higher risk causes insurance companies to charge higher risk premium and vice versa. This relationship is fair or logical, because a higher risk attracts higher propensity of claim and putting a higher premium, also makes the people to take care of themselves. As a result,  a case of adverse selection and moral hazard on the part of people, decrease.

7.

It is the trust developed and faith of the people, investors and nations who hoard the US currency, that back the US money supply. These entities have hold trust that their ownership of US dollar and its inherited values, will be honored by the government of the USA. It is the basis of backing and making US currency as an international currency used for international trade.