Question

2. Assess each comment and either True, False, or Uncertain. Be sure to explain your response.

(a.) “Typically speaking, one should expect that the federal funds rate will rarely be above the discount rate.”

(b.) “By paying interest on reserve accounts, the Fed is limiting the effects of infation resulting from its balance sheet expansion during and after the Fnancial crisis.”

Answer 1

a)“Typically speaking, one should expect that the federal funds rate will rarely be above the discount rate.”--TRUE

Banks that need to boost their funds overnight typically borrow from other banks at the fed funds rate.

Financial institutions also have other means of borrowing, one of which is to borrow directly from the Federal Reserve via the “discount window.” The rate at which the Fed lends to banks via this facility is known as the “discount rate.”The Fed can adjust the discount rate independently from the fed funds rate. The discount rate is typically higher than the fed funds rate, so it is used as a last resort by banks that need to borrow. For example, in early 2012 the primary discount rate was 0.75%, while the fed funds rate was targeted in a range from 0% to 0.25%. Bank borrowers also need to put up collateral to borrow from the discount window, and the Federal Reserve banks can opt not to extend a discount window loan.

b()The ability to pay interest on bank reserves allows a central bank to leverage its assets and dramatically increases its capacity to take fiscal risk, which ultimately spills over to the budget constraint of the fiscal authorities.--TRUE

The ability to pay interest on bank reserves allows a central bank to leverage its assets and dramatically increases its capacity to take fiscal risk, which ultimately spills over to the budget constraint of the fiscal authorities.