Question

1. Assume that banks fund thirty year fixed rate mortgages with 1 year year certificates of deposit. If the yield curve flattens out then the spread between the yields a bank earns on            its assets and the cost of funding these assets will decline.

     True

     False

2. The following statement makes sense:

    In reaction to the COVID-19 crisis the FOMC has made a commitment to reduce the SOMA of the Federal Reserve in order to pump more money into the financial system.

   True

   False

3. This would be a sensible monetary policy:   

In reaction to the COVID-19 health/economic crisis of the FOMC has decided to expand only the asset side the Federal Reserve balance sheet.

True

False

Answer 1

Ans-1)TRUE.

REASON- A yield curve shows graphical relationship between the interest rates(yaxis) and the maturity period(x axis).The bank funds the long term loans by short term securities. A rise in interest rate of short term security would make the funding of long term loans more expensive for the banks(becuase banks buy short term securities at low rates and sell long term loans at high rates)Hence, high priced short term securities will lower their yield in long run by increasing their cost. Thus a flattening yield curve means that the spread between bank's yield and cost of funding long term assets decline. Whereas a steeper yield curve increases the spread between yield and cost.

Ans-2) FALSE.

REASON- FOMC stands for FEDERAL OPEN MARKET COMMITTEE. SOMA stands for SYSTEM OPEN MARKET ACCOUNT. So SOMA is a management tool of monetary policy which holds all the assets acquired by open market operations. Now here in the statement , it is talking about reducing SOMA for pumping money in economy but this is not possible as a reduction in SOMA would mean selling some assets in the market. And selling by open market operations absorba the money from the economy instead of pumping the money. However , an increase in SOMA i.e buying operations can increase money flow as it will put money in hands of the people. So the above statement is false.

Ans-3)FALSE.

REASON- Due to COVID-19/health/economic crisis , there is a need to inject money into the economy to save us from the crisis. Now talking about the FED balance sheet, THE ASSET side expands whenever the FED buys an asset. Buying asset means the FED is giving money to the seller(may be govt,banks etc). This means that the banks get more money if the FED expands asset and this money is then circulated or pumped into the economy as loans. SO buying assets increases the money flow which is the need of the hour. So it is apt to expand asset side. BUT SAYING that expansion of asset side only will be incorrect.The liability side of the balance sheet increases or decreases when FED buys or sells the assets.e.g the money with the public is a liability of FED , so when the FED expands assets ,it also increases money in hands of public and also increases its liability. So if there is expansion of assets , there will also be expansion of liability.