Here are the answers with discussion for this Weekend’s Quiz. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of Modern…
Saturday Quiz – October 9, 2010
Welcome to the billy blog Saturday quiz – Maastricht 2010 Edition. The quiz tests whether you have been paying attention over the last seven days. See how you go with the following five questions. Your results are only known to you and no records are retained.
Quiz #81
- 1. If we assume that inflation is stable, there is excess productive capacity, and the central bank maintains its current monetary policy setting then if government spending increases by $X dollars and private investment and exports are unchanged nominal income will continue growing until the sum of taxation revenue, import spending and household saving rises by more than $X dollars because of the multiplier.
- True
- False
- Maybe
- 2. When a government such as the US government voluntarily constrains itself to borrow to cover its net spending position, it substitutes its spending for the borrowed funds and logically reduces the private capacity to borrow and spend.
- True
- False
- Maybe
- 3. When the national government's budget balance moves into deficit:
- it is a sign that the government is trying to stimulate the economy.
- it is a sign that the government is worried that unemployment is rising.
- you cannot conclude anything about the government's policy intentions.
- 4. The crucial difference between a monetary system based on the convertible currency backed by gold and a fiat currency monetary is:
- that under the former system, excessive national government spending led to inflation.
- that under the former system, the national government had to issue debt to cover spending above taxation.
- that under the former system, the national government could not use net spending to achieve full employment.
- 5. This is the premium question for this week: In Year 1, the economy plunges into recession with nominal GDP growth falling to minus -1 per cent. The inflation rate is subdued at 1 per cent per annum. The outstanding public debt is equal to the value of the nominal GDP and the nominal interest rate is equal to 1 per cent (and this is the rate the government pays on all outstanding debt). The government's budget balance net of interest payments goes into deficit equivalent to 1 per cent of GDP and the debt ratio rises by 3 per cent. In Year 2, the government stimulates the economy and pushes the primary budget deficit out to 2 per cent of GDP and in doing so stimulates aggregate demand and the economy records a 4 per cent nominal GDP growth rate. All other parameters are unchanged in Year 2. Under these circumstances, the public debt ratio will rise but by an amount less than the rise in the budget deficit because of the real growth in the economy.
- True
- False
- Maybe
Sorry, quiz 81 is now closed.
You can find the answers and discussion here
Off-topic but and from:
“Greenspan said that if the Fed decides to expand its balance sheet through purchases of bonds, a process known as quantitative easing, it may not be enough to get “money moving” and spur growth in the U.S. economy.
Should the Fed increase “excess reserves and they just sit there on the asset side of commercial banks’ balance sheets not being relent, you’ve merely gone through an interesting bookkeeping exercise,” Greenspan said. “You’ve got to break that psychology that prevents that current trillion” in reserves from being relent, he said.”
Tell me that is as wrong as I think it is at first glance.
Here is the link for above:
http://www.bloomberg.com/news/2010-10-08/greenspan-says-u-s-engaged-in-dangerous-game-as-debt-deficits-increase.html
Fed Up,
You are correct. The phrase “not being relent” is what makes it totally wrong.
Unfortunately, somebody sent the same quote to Warren Mosler, but eliminated that phrase from the quote (who knows why?).
As a result Mosler was misled on the original quote, interpreted the one he saw, and posted it as MMT supportive.
For JKH or anyone, here is a quote from By Scott Fullwiler, Associate Professor of Economics at Wartburg College
“The third aspect of operational realities is what is not possible given the accounting and the tactical logic. A good example here is the traditional money multiplier model that assumes central banks target reserve levels or the monetary base in order to target a monetary aggregate via a money multiplier. But the money multiplier gets both the accounting logic and the tactical logic of the monetary system wrong. For the former, as noted above, loans create deposits and the creation of more bank liabilities does not require that banks hold more reserve balances; banks do use reserve balances to settle payments and meet reserve requirements, but the quantity of reserve balances held for these purposes is mostly unrelated to growth in monetary aggregates.”
The quick version I thought was correct.
Loans create deposits.
The loan part has a capital requirement “stuck onto to it”.
The deposits part has a reserve requirement “stuck onto to it”.
Is that not correct?
I am pretty sure there is more than one capital requirement depending on the loan’s risk.
Is there more than one reserve requirement?
Now whether sweeps accounts lower the effective reserve requirement is a somewhat different story.
Thanks in advance.
Link for above:
http://www.nakedcapitalism.com/2010/08/guest-post-modern-monetary-theory-%e2%80%94-a-primer-on-the-operational-realities-of-the-monetary-system.html
JKH or anyone else, here is what I thought happened.
If more loans were made when there are excess reserves, the excess reserves would become required reserves to meet the reserve requirement. The excess reserves are already there so there is no upward “pressure” on the fed funds overnight rate.
Is that correct?
Fed U.,
Looks OK to me.
(Fullwiler is always right on banking operations.)
Capital is assigned according to type of risk – credit risk, interest rate risk, operational risk, etc.
E.g. a loan will generate a credit risk capital requirement on its own, but may generate an interest rate risk capital requirement in combination with its funding (e.g. fixed rate loan funded by floating rate deposit).
Where there is a reserve requirement, it is a single requirement depending on type of deposit (e.g. checking, saving).
For JKH or anyone else and from above:
“For the former, as noted above, loans create deposits and the creation of more bank liabilities does not require that banks hold more reserve balances; banks do use reserve balances to settle payments and meet reserve requirements, but the quantity of reserve balances held for these purposes is mostly unrelated to growth in monetary aggregates.”
I don’t get this part if the reserve requirement is not 0% (a positive requirement).
JKH said: “Where there is a reserve requirement, it is a single requirement depending on type of deposit (e.g. checking, saving).”
Over at Mish’s blog, I once read that the reserve requirement on savings accounts is zero. Is that correct?
So if I deposit a demand deposit in my checking account and the bank uses a “sweep account” on it, does that lower the effective reserve requirement so more debt (loans and deposits) can be created without putting upward “pressure” on the fed funds overnight rate?
Fed U.,
“For the former, as noted above, loans create deposits and the creation of more bank liabilities does not require that banks hold more reserve balances”
This means there is no operational or accounting reason for a bank to need reserves in order to make a loan; the loan transaction is a debit to the loan account and a credit to the deposit account (of the borrower). Assets equal liabilities. The accounts are balanced. No reserves are needed.
There may be a lagged requirement imposed by regulatory authorities, but that has nothing to do with any operational or accounting rationale.
With respect to the ultimate movement of loaned funds out of the lending bank – reserves are used operationally for interbank payments, but the netting process means stocks of reserves needed for this purpose bear virtually no relationship to the stocks of outstanding assets and liabilities of the banking system, and therefore virtually no relationship to the methodology by which regulatory reserve requirements are calculated.
And monetary aggregate growth bears little relationship to required reserve growth when most deposits attract no reserve requirement. (This applies to most but not all deposits in US banks).
And regulatory reserve requirements per se have virtually nothing to do with the overnight interest rate. The central bank manages the interest rate either by managing the differential between aggregate reserves supplied to the system and aggregate required reserves or by paying interest on reserves.
JKH said: “This means there is no operational or accounting reason for a bank to need reserves in order to make a loan; the loan transaction is a debit to the loan account and a credit to the deposit account (of the borrower). Assets equal liabilities. The accounts are balanced. No reserves are needed.”
Until the deposit account holder withdraws currency?
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And, “And monetary aggregate growth bears little relationship to required reserve growth when most deposits attract no reserve requirement. (This applies to most but not all deposits in US banks).
And regulatory reserve requirements per se have virtually nothing to do with the overnight interest rate.”
I thought Bill said the reserve requirement was 10% (checking accounts???) in the USA. Let’s assume a 10% reserve requirement and no sweeps accounts. Would more debt production (loans and deposits) eventually lead to a shortage of reserves if the fed or some other source was not found for more of them raising the overnight fed funds rate?
***
***
Again, “And monetary aggregate growth bears little relationship to required reserve growth when most deposits attract no reserve requirement. (This applies to most but not all deposits in US banks).”
Do you have a list of the different reserve requirements for deposits or a link?
Is a near zero or zero reserve requirement one thing needed for an unlimited amount of debt to be produced?
Thanks in advance!!!