Skip to content

FRM Part II · FRM Exam Part II · Monetary and Fiscal Policy: Safeguarding Stability and Trust

A central bank wants to lower short-term market interest rates in a system where commercial banks hold large excess reserves. Which of the following is the most effective conventional tool for guiding overnight rates in such a system?

Changing the interest rate paid on reserve balances is most effective. When reserves are abundant, banks will not lend below the rate the central bank pays on reserves, so that administered rate anchors overnight rates, whereas small open market operations have little effect on rates.

  1. AChanging the interest rate paid on reserve balancesCorrect
  2. BRaising the statutory reserve requirement ratio
  3. CConducting small open market sales of government bills
  4. DImposing credit ceilings on bank lending

Explanation

With abundant reserves, banks have no need to borrow in the interbank market at rates above the rate paid on reserves, so the administered rate on reserves sets a floor for overnight rates. Small open market operations barely change rates because reserves are already in surplus. Reserve requirements and credit ceilings are not the standard rate-steering tools in this regime.

Did you get it right without looking?

One question tells you little. A timed set on Monetary and Fiscal Policy: Safeguarding Stability and Trust shows your real accuracy, how long you take and where you lose marks.

Practise Monetary and Fiscal Policy: Safeguarding Stability and TrustFree diagnostic mock

More Monetary and Fiscal Policy: Safeguarding Stability and Trust questions