Itís Ok to Borrow from the Fed

1. Name and define each of the three tools of monetary policy.

The three tools of monetary policy are open market operations, reserve ratio, and the discount rate. Open market operations are the act of the Central Bank buying or selling securities in the open market. The reserve ratio is the percentage of deposits that banks must hold on reserve at the Federal Reserve. They may be held in the form of deposits at the Fed or as cash in their vaults. The discount rate is the rate the Federal Reserve charges to make loans to banks. The lending operation is carried out at each of the regional Federal Reserve Bankís lending facilities, referred to as the discount window.

2. Visit and identify the three different types of lending that occur at the discount window.

The discount window of the Fed offers three types of loans, primary credit, secondary credit, and seasonal credit. Each of these has its own interest rate. The students will find the following paragraph which describes each program:

Under the primary credit program, loans are extended for a very short term (usually overnight) to depository institutions in generally sound financial condition. Depository institutions that are not eligible for primary credit may apply for secondary credit to meet short-term liquidity needs or to resolve severe financial difficulties. Seasonal credit is extended to relatively small depository institutions that have recurring intra-year fluctuations in funding needs, such as banks in agricultural or seasonal resort communities.

Multiple Choice/True False Questions

1. The discount rate is:
  1. the rate banks charge their best customers.
  2. the amount of deposits banks must hold on reserve.
  3. the rate banks pay to borrow from the Fed.
  4. Vnone of the above.
ANS. c

2. Historically, borrowing from the Fed:
  1. was seen as a sign of weakness.
  2. has been limited to credit unions.
  3. was preferred to borrowing from another bank.
  4. None of the above.
ANS. a

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