SN548 Money and Banking Version 1 Questions

Explanation

Price stability is a core objective of central banks like the Federal Reserve, defined as maintaining low and stable inflation over time. When the average price change across a broad market basket of goods and services is near zero, it indicates that inflation is under control and purchasing power is preserved. A value of 'one', 'five', or 'seven' would imply measurable inflation, which contradicts the definition of price stability. For example, a 5% average price change signifies significant inflation, not stability. Therefore, the only level consistent with price stability is when the average change is near zero. This allows consumers and businesses to make long-term financial decisions without uncertainty about future prices. Hence, option A is correct because price stability does not mean prices never change, but that the overall trend in the price level is flat or nearly flat.

Explanation

Under the Prompt Corrective Action (PCA) framework established by U.S. banking regulators, a bank is classified as 'well capitalized' if it meets several capital requirements, one of which is a Total Risk-Based Capital ratio of at least 10.0%. This ratio is calculated as total capital (Tier 1 plus Tier 2) divided by risk-weighted assets. The other classifications are: adequately capitalized (8.0%), undercapitalized (less than 8.0%), significantly undercapitalized (less than 6.0%), and critically undercapitalized (less than 2.0%). Options A (6.5%) and B (8.2%) fall below or within the 'adequately capitalized' range but do not meet the 'well capitalized' threshold. Option D (12.0%) is higher than required and not the minimum. Therefore, the minimum ratio that qualifies a bank as well capitalized is 10.0%, making C the correct answer.

Explanation

Inflation targeting is a monetary policy framework in which the central bank sets a specific numerical target for the inflation rate over the medium to long term and communicates this target to the public. This strategy enhances transparency and accountability, anchoring inflation expectations and helping to achieve long-run price stability. While open market operations (B) are a tool used to implement monetary policy, they are a mechanism, not a strategic framework. Pump-priming (A) refers to short-term fiscal stimulus, not a monetary tool. Discretionary funding (C) is not a standard monetary policy term. Inflation targeting has been adopted by many central banks, including the Bank of England and the Reserve Bank of New Zealand, and is widely regarded as effective in maintaining stable prices over time. By focusing on inflation as the primary goal, central banks can avoid the pitfalls of monetary growth rules or exchange rate pegs that may conflict with domestic economic conditions. Thus, D is correct because inflation targeting directly aims at long-run price stability.

Explanation

During the 2007–2008 financial crisis, the Federal Reserve reduced the discount rate and introduced the Term Auction Facility (TAF), which used auctions to allocate funds to banks. The primary goal of these actions was to generate liquidity in the financial system. As credit markets froze and interbank lending declined, banks faced acute funding shortages. By lowering the discount rate, the Fed made it cheaper for banks to borrow directly from the central bank. The auction mechanism allowed for broader access to funds while maintaining some market discipline. These measures were not primarily about transparency (A), though auctions did add some, nor about controlling volatility (B) or stabilizing outcomes (D) in a general sense. The immediate and urgent need was to inject liquidity into the banking system to prevent a collapse of credit markets. Therefore, the correct answer is C: generating liquidity, as this was the central purpose of these emergency lending tools.

Explanation

Money must fulfill three primary functions: it must serve as a medium of exchange, a unit of account, and a store of value. Among the options, 'a store of value' (A) is a fundamental characteristic. While legislative approval (B) may support the use of fiat money, it is not necessary—historically, commodities like gold functioned as money without government decree. Acceptance by a UN committee (C) is irrelevant, as no such requirement exists. Being based on natural resources (D) applies to commodity money but not to fiat money, which derives value from government backing and public trust. The key point is that an item must retain value over time to be useful as money. If it depreciates rapidly (like perishable goods), it fails as a store of value and thus cannot function effectively as money. Therefore, A is correct because being a store of value is essential to the definition of money.