What is the case in favor of fed independence

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1. What are the eight basic facts about the financial structure in the U.S. economy? How do some of these facts compare with other developed economies such as Germany, Japan, and Canada?

2. How do transactions costs influence financial structure?

3. How do financial intermediaries reduce transactions costs?

4. Explain how adverse selection (the lemons problem) affects the stock and bond markets.

5. What tools are available from the private sector, the government, and financial intermediaries to reduce the asymmetric information and the resulting adverse selection problems in the financial system?

6. Explain how the principal-agent problem (i.e., moral hazard problem in equity contracts) affects the choice between debt and equity contracts.

7. What tools are available from the private sector, the government, and financial intermediaries to reduce the asymmetric information and the resulting principal-agent problem?

8. Explain how the moral hazard problem affects debt markets.

9. What tools are available to reduce the asymmetric information and the resulting moral hazard problem in debt contracts (such as bonds, loans)?

10. Explain how underdeveloped financial systems in developing and transition economies can lead to low economic development and growth. Discuss in terms of the unavailability of tools used by advanced economies to lower adverse selection and moral hazard problems.


1. What is a financial crisis?

2. Explain the dynamics of financial crises in advanced economies in terms of the three stages: initiation of the crisis, banking crisis, and debt deflation.

3. For advanced economies, explain the three ways in which financial crises are likely to begin (i.e., the first stage of the crisis): mismanagement of financial innovation/liberalization, asset price boom and bust, and increase in uncertainty

4. What were the causes of the 2007-2009 financial crisis?

5. What are the five key areas of the U.S. economy where the 2007-2009 crisis had a major impact?

6. List the government interventions at the peak of the 2007-2009 financial crisis that were aimed at propping up financial markets and stimulating the economy.

7. Explain the dynamics of financial crises in developing economies in terms of the three stages: initiation of the crisis, currency crisis, and full-fledged financial crisis.

8. For Stage 1, explain the two major paths along which financial crises are likely to develop in developing economies: mismanagement of financial liberalization/globalization and severe fiscal imbalances

9. Besides the two paths explained in question #5, what additional factors can play a role in the first stage in crises in developing economies? 10. In developing economies, explain how the deterioration of bank balance sheets and severe imbalances in stage 1 lead to a currency crisis in stage 2.

11. In developing economies, explain how the currency crisis in stage 2 leads to full-fledged financial and banking crisis in stage 3.

12. Outline the main features of the financial crises in Mexico, East Asia, and Argentina in the 1990s.


1. Explain the following characteristic about a bank's balance sheet in terms of the sources and uses of bank funds: "total assets = total liabilities + bank capital."

2. What are the liabilities found on a bank's balance sheet?

3. Of the following three categories of bank liabilities--checkable deposits, nontransaction deposits, and borrowings - which represents (a) the largest source of bank funds, and (b) the least costly source of bank funds?

4. How does a bank raise capital? What role does bank capital play in the event of a drop in the value of a bank's assets?

5. What are the assets found on a bank's balance sheet? Which is the largest category of assets on a bank balance sheet?

6. What is the reserve requirement on bank deposits?

7. Using T-accounts (which only show the changes to a balance sheet resulting from a transaction) explain what is the effect of a bank receiving additional customer deposits on its bank reserves? What is the effect of a bank losing customer deposits?

8. Explain the following principles of bank management

a. Liquidity management

b. Asset Management

c. Liability management

d. Capital adequacy management

9. If a bank has ample excess reserves, a deposit outflow (resulting from customers withdrawing funds from their accounts or writing checks against their accounts) does not require a bank to make changes in other parts of its balance sheet. However, if there are

deposit outflows and a bank does not have sufficient excess reserves, what are the options available to a bank to acquire reserves and thereby eliminate the shortfall of reserves?

What is the cost associated with each option?

10. Explain the relationship between the amount of bank capital and the safety of the bank. Explain the relationship between the amount of bank capital and the return on equity (ROE) to owners of a bank.

11. Describe the trade-off between bank safety and returns faced by owners of a bank when they decide how much capital to invest in the bank. 12. Does the government believe that banks would hold sufficient capital on their own? If not, what government requirements are aimed at ensuring capital adequacy in the banking system?

Important Formulae:

1. Total assets = Total liabilities + Bank Capital (also known as equity capital)

2. Total Reserves = Required reserves + Excess reserves

3. Required reserves (in $) = required reserve ratio (%) x Volume of deposits (in $)


1. Explain the role of asymmetric information in shaping financial regulation. What are the ten basic categories of financial regulation?

2. Explain the different forms of the government safety net.

3. Why is government provided deposit insurance needed in the economy?

4. What is the moral hazard associated with the government safety net?

5. What is the adverse selection problem associated with the government safety net?

6. What is the "too big to fail" problem?

7. Explain why regulators need to impose restrictions on asset holdings at banking institutions to minimize moral hazard.

8. Explain how government mandated capital requirements are also a way of minimizing moral hazard at banking institutions.

9. What are the five classifications of banks based on bank capital? Why is prompt corrective action necessary when bank capital falls to low levels (i.e., for banks in groups 4 and 5)?

10. Explain how financial supervision (chartering of banks and bank examinations) is supposed to lower adverse selection and moral hazard in the banking industry. Carefully discuss CAMELS rating and call reports that banks file on a regular basis.

11. Why is it important to assess the soundness of a bank's management process with regard to controlling risk? Discuss the risk management rating banks given to banks as part of their bank examination, banks stress tests which calculate bank losses under dire scenarios and the need for more capital.

12. What role do disclosure requirements play in the financial system? What regulations have been imposed in the U.S. for the purpose of increasing disclosure?

13. What are the forms of consumer protection regulation that have been enacted in the U.S.?

14. What are the advantages and disadvantages of restrictions on competition in the banking industry?

15. What is the difference between microprudential supervision and macroprudential supervision? Why is focus on microprudential supervision not enough?


1. What factors were the sources of resistance to the establishment of a central bank in the U.S. before 1913?

2. Explain in detail each of the following components of the structure of the Federal reserve System

a. Board of Governors

b. Federal Reserve Banks

c. Federal Open Market Committee (FOMC)

d. Member Banks (and their Board of Directors

3. What is the meaning of goal independence? What is the meaning of instrument independence?

4. What factors explain the high degree of independence of the Fed?

5. What factors limit the independence of the Fed?

6. What is the case in favor of Fed independence? What is the case against Fed independence?

7. What is the theory of bureaucratic behavior? Is it applicable to the Fed's actions?

8. Briefly explain the independence of the following central banks:

a. European Central Bank

b. Bank of Japan

c. Bank of England

d. Bank of Canada

Reference no: EM13181157

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