California Real Estate Salesperson Exam Practice - Quesiton 38

Question

If the Federal Reserve wants to increase the amount of money available to member banks to ease a tight money market, it could:

Selections

• A. Raise the discount rate to its member banks

• B. Lower the minimum reserves required by its member banks

• C. Raise the minimum reserves required by its member banks

• D. Sell government bonds 

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Answer: B

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5 Keys Summary

• To ease a tight money market (when demand for money is high and supply is low), the Federal Reserve must employ expansionary monetary policy to stimulate economic growth.

• The correct expansionary action available to the Federal Reserve (the Fed) is to lower the minimum reserves required by its member banks.

• Reserve requirements are the amounts of cash or credit deposits banks must set aside; reducing these requirements allows banks to lend out a significantly higher percentage of their deposited funds.

• This action increases the total supply of funds in the banking system, making more money available for loans to consumers and businesses.

• Actions like raising the discount rate, raising minimum reserves, or selling government securities are all considered contractionary policies intended to slow down the economy and decrease the money supply.

Explanations

To increase the amount of money available to member banks and stimulate economic growth, the Federal Reserve employs expansionary monetary policies.

• Lowering the minimum reserves required by its member banks is an expansionary action. When reserve requirements are lower, banks are permitted to lend out a much higher percentage of their deposited funds. This increases the amount of funds in circulation for the banking system, which can then be loaned out to consumers and businesses.

• Raising the discount rate (A) is considered a contractionary action, as it discourages banks and borrowers from lending and spending more due to the higher cost of borrowing.

• Raising the minimum reserves required by its member banks (C) is also a contractionary action. It means banks must set aside more money, resulting in fewer dollars available to be loaned to individual and business borrowers.

• Selling government bonds (D) is an open market operation that decreases the amount of capital available for banks, thereby contracting or slowing the overall economy byreducing the money supply. To increase the money supply, the Fed would purchase securities. Therefore, lowering the minimum reserve requirements is the correct action to increase money availability in a tight money market.

Concepts Definitions

• Federal Reserve (the Fed): The central banking system of the United States, which regulates commercial banks and implements monetary policy to stabilize the national economy.

• Monetary Policy: The actions of a central bank (like the Federal Reserve) that directly impact the rate of growth of the money supply, primarily through modifying short-term interest rates, buying and selling government bonds, and changing reserve requirements for banks.

• Tight Money Market: An economic condition where the demand for money is greater than its supply, leading to higher interest rates and stricter lending standards. The Fed would aim to ease this with expansionary policies.

• Discount Rate: The interest rate that Federal Reserve Banks charge commercial banks in their districts for short-term loans. Lowering this rate is expansionary.

• Reserve Requirements: The amounts of cash or credit deposits that banks must set aside and hold in their vaults or at a Reserve Bank, as determined by the Federal Reserve. A reduction in these requirements increases the funds available for lending.

• Open Market Operations: The most frequently used tool by the Federal Reserve to stimulate the economy, involving the buying and selling of government securities or bonds to expand or contract the money supply. Purchasing securities injects money into the system, while selling securities decreases it.