ECON3311 Exam 3 Study Guide

Bank Runs

Bank Runs

When depositors rush to withdraw their money from a bank due to fear of insolvency or lack of liquidity.

Solvency

The condition where a bank's assets exceed its liabilities, indicating positive net worth.

Liquidity

The ability of a bank to meet depositors' demand for withdrawal by having sufficient reserves and marketable assets.

Contagion

The spread of panic among depositors, causing them to withdraw their funds from multiple banks.

Panics

A widespread bank run that occurs when depositors fear that their bank may fail, leading to a cascading effect.

Crisis

A financial crisis caused by factors such as declining housing prices and increased mortgage defaults, resulting in bank failures and decreased lending.

Lender of Last Resort

The role of the government or central bank in providing loans to banks facing sudden deposit outflows to prevent their failure.

Deposit Insurance

A guarantee that depositors will receive the full value of their accounts if a financial institution fails.

Regulatory Requirements

Regulations imposed on banks to minimize the cost of their failure, including obtaining a charter, capital requirements, and disclosure of balance sheet information.

Supervision

The enforcement of banking regulations through monitoring, inspection, and examination of banks to ensure compliance.

CAMELS Criteria

A set of criteria used by supervisors to evaluate the health of banks, including Capital Adequacy, Asset Quality, Management Earnings, Liquidity, and Sensitivity to Risk.

Stress Tests

Evaluations conducted by central banks to assess the capital needs of banks under different economic scenarios, ensuring their solvency and stability.

Central Bank

A financial institution that manages government finances, controls the money supply, acts as a lender of last resort, and oversees commercial banks.

Monetary Policy

The actions taken by a central bank to control the availability of money and credit in the economy, usually through adjusting interest rates.

Dual Mandate

The responsibility of a central bank to maintain price stability and maximum sustainable employment.

Central Bank Independence

The concept that central banks should be free from political pressures and have control over their budgets and policies.

Open Market Operations

The buying and selling of securities by a central bank to influence the supply of reserves and interest rates in the market.

Federal Funds Rate

The interest rate at which banks lend to each other overnight, influenced by the actions of the central bank.

Taylor Rule

A guideline used by central banks to set interest rates based on factors such as the natural rate of interest, inflation, and output gaps.

Forward Guidance

The communication of a central bank's intentions regarding future monetary policy to influence long-term interest rates and private spending.

Sets future expectations lower

Refers to the practice of lowering future expectations, which can have downsides such as lack of consensus on the best announcement to reach a goal and unintended consequences like asset price bubbles.

Quantitative Easing

The central bank supplies aggregate reserves beyond the quantity needed to lower the policy rate to its target, usually 0 or lower. It involves open-market purchases and lending that increase bank reserves, expanding the size of the central bank's balance sheet.

Targeted Asset Purchasing

The central bank alters the mix of assets it holds on its balance sheet to change their relative prices and stimulate economic activity. It involves buying different assets than usual, such as longer-term Treasury bonds and mortgage-backed securities, to influence the cost and availability of credit.

Discount Lending

The Fed's primary tool for ensuring short-term financial stability, eliminating bank panics, and preventing the sudden collapse of institutions experiencing financial difficulties. It involves making loans to banks when no one else will, with three types of loans:primary credit loan, secondary credit loan, and seasonal credit.

Interest on Reserve Balances (IORB)

The interest rate that banks earn from the Fed on the funds they deposit in their reserve balance accounts. It is a risk-free investment option for banks, and the rate is set by the Fed.

Traditional Monetary Policy

Involves using interest rates and exchange rates to stabilize the economy and keep inflation low. The interest rate channel and exchange rate channel are the main mechanisms through which traditional monetary policy operates.

Unconventional Monetary Policy

Used when lowering the target interest rate to zero or when an impaired financial system prevents conventional interest rate policy from supporting economic growth. It includes a variety of tools, such as quantitative easing and forward guidance, to supplement conventional policy.

Lower Bound & Zero Lower Bound

The lower bound refers to the point where nominal interest rates cannot fall below zero. The zero lower bound is the idea that a nominal interest rate cannot fall below zero, although recent experience shows that rates can be lowered below zero due to transaction costs.

Policies Related to Bubbles

"Leaning against bubbles" refers to raising interest rates to discourage bubbles from developing. Opponents argue that bubbles are difficult to identify and that central banks should wait until the bubble bursts to react. The impact of a scandal on the relationship between the monetary base and the money supply would depend on the specific circumstances and public confidence in the banking system.

Currency-to-deposit ratio

The ratio that measures the public's desire to hold currency relative to deposits, likely to increase due to a scandal.

Excess reserve-to-deposit ratio

The ratio that measures the level of excess reserves held by banks in anticipation of public reaction, likely to increase due to a scandal.

Money multiplier

The ratio that determines the amount of money that can be created from a given monetary base, likely to decrease due to changes in currency-to-deposit and excess reserve-to-deposit ratios.

Interest rate on excess reserves (IOER)

The interest rate controlled by the Federal Reserve, likely to be increased to implement a rise in the target range for the federal funds rate.

Market federal funds rate

The interest rate at which banks borrow in the money markets from nonbank participants, likely to be influenced by the change in the IOER rate.

Federal Reserve buying of mortgage-backed securities

The action taken by the Fed to purchase MBS in order to lower mortgage rates, increase home sales, raise house prices, and promote housing construction.

Central bank's balance sheet

The financial statement that shows the assets and liabilities of the central bank, changes to which may not immediately affect the size of the banking system's balance sheet.