Macro econ chapter 14
Which one of the following is not the formula for the quantity theory of money? How does the quantity theory provide an explanation about the cause of inflation?
M x Y = P x V The quantity equation shows that if the money supply grows at a faster rate than real GDP, then there will be inflation.
The Federal Reserve uses two definitions of the money supply, M1 and M2, because
M1 is a narrow definition focusing more on liquidity, whereas M2 is a broader definition of the money supply.
Suppose you decide to withdraw $100 in currency from your checking account. What is the effect on M1 LOADING... ? Ignore any actions the bank may take as a result of your having withdrawn the $100
M1 remains unchanged.
Which of the following is a monetary policy LOADING... tool used by the Federal Reserve Bank?
A. Buying $500 million worth of government securities, such as Treasury bills. B. Increasing the reserve requirement from 10 percent to 12.5 percent. C. Decreasing the rate at which banks can borrow money from the Federal Reserve
Which of the following is included in M2 but not M1?
Money market deposit accounts in banks
The Federal Reserve acting as the lender of last resort to prevent a bank panic
constitutes offering discount loans to distressed banks, but the "bail out of the banks" involved providing funds to the banks in exchange for ownership in those banks.
The quantity theory of money is better able
to explain the inflation rate in the long run.
In a fractional reserve banking system LOADING... , what is the difference between a "bank run" and a "bank panic?"
A bank run involves one bank; a bank panic involves many banks.
In an article in the American Free Press, Professor Peter Spencer of York University in England is quoted as saying: "This printing of money 'will keep the [deflation] wolf from the door'." In the same article, Ambrose Evans-Pritchard, a writer for the London-based newspaper The Telegraph, is quoted as saying: "Deflation has...insidious traits. It causes shoppers to hold back. Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop." Source: Doug French, "We Should Celebrate Price Deflation," American Free Press, November 17, 2008. What is price deflation? What is meant by Professor Spencer's statement "This printing of money 'will keep the [deflation] wolf from the door'"? Why would deflation cause "shoppers to hold back," and what does Evans-Pritchard mean when he says, "Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop"?
A fall in the price level. An increase in the money supply that exceeds the rate of growth of GDP will increase the price level. Consumers delay purchases, expecting prices to fall more, and the lack of demand causes prices to fall further.
In April 2009, the African nation of Zimbabwe suspended the use of its own currency, the Zimbabwean dollar. According to an article from the Voice of America, "Hyperinflation in 2007 and 2008 made Zimbabwe's currency virtually worthless despite the introduction of bigger and bigger notes, including a 10 trillion dollar bill." Zimbabwe's Economic Planning Minister, Elton Mangoma, was quoted as saying the Zimbabwean dollar "will be out for at least a year," and in January 2009, the government of Zimbabwe made the U.S. dollar the country's official currency. Source: Voice of America News, "Zimbabwe Suspends Use of Own Currency," voanews.com, April 12, 2009. Why would hyperinflation make a currency "virtually worthless"? How might using the U.S. dollar as its currency help to stabilize Zimbabwe's economy?
A high rate of inflation causes money to lose its value so rapidly that households and firms avoid holding it. Households and businesses will be able to use and hold the currency without the worry that it will rapidly lose its value.
Do you agree or disagree with the following statement? "Most of the money supply of the United States is created by banks making loans."
Agree. When a bank's reserves increase, they make more loans, which creates more checking deposits and increases the money supply.
Distinguish among money, income, and wealth. The central bank of a country controls the money supply, which equals the currency held by
A person's money is the currency held and the checking account balance, income is the earning and wealth is equal to value of assets minus all debts. the public plus their checking acount balances.
Suppose you have $2000 in currency in a shoebox in your closet. One day, you decide to deposit the money in a checking account. How will this action affect the M1 LOADING... and M2 LOADING... definitions of the money supply?
Both M1 and M2 will remain unchanged.
Which of the following is not a function of money?
Commodity.
An article on The Motley Fool Web site states: Deposits are the lifeblood of banks. Bank of America for example, had nearly $1 trillion in deposits at the end of March, representing nearly half of its total liabilities. Citigroup and Wells Fargo held around $800 billion each in deposits at the end of the first quarter. Source: Matt Koppenheffer, "Should Your Bank Deposits Be at Risk?" www.fool.com, May 21, 2009. What does the article mean by "deposits are the lifeblood of banks"?
Deposits are essential to banks, and without them, they cannot survive.
Briefly explain whether you agree or disagree with the following statement: "Assets LOADING... are things of value that people own. Liabilities are debts. Therefore, a bank will always consider a checking account deposit to be an asset and a car loan to be a liability."
Disagree. Checking accounts represent something that the bank owes to the owner of the account. It is a bank liability.
Do you agree or disagree with the following statement? "I recently read that more than half of the money issued by the government is actually held by people in foreign countries. If that's true, then the United States is less than half as wealthy as the government statistics indicate."
Disagree. Money is currency plus checking deposits. Wealth is the value of assets minus debts.
Which of the following best explains the difference between commodity money and fiat money?
Fiat money has no value except as money, whereas commodity money has value independent of its use as money.
What is the "shadow banking system"? The financial firms of the shadow banking system were
Financial firms that raise money from investors and provide it to borrowers. more vulnerable than commercial banks to bank runs because they were more highly leveraged than commercial banks.
Suppose that Congress changes the law to require all firms to accept paper currency in exchange for whatever they are selling. All of the following are correct except:
Firms lose since they don't have the convenience of credit cards.
A newspaper article contains the statement: "Income is only one way of measuring wealth." Source: Sam Roberts, "As the Data Show, There's a Reason the Wall Street Protesters Chose New York," New York Times, October 25, 2011. Do you agree that income is a way of measuring wealth?
Income is yearly earnings and it doesn't measure wealth which is the value of personal assets less all debts.
In the late 1940s, the Communists under Mao Zedong were defeating the government of China in a civil war. The paper currency issued by the Chinese government was losing much of its value, and most businesses refused to accept it. At the same time, there was a paper shortage in Japan. During these years, Japan was still under military occupation by the United States. Some U.S. troops in Japan realized that they could use dollars to buy up vast amounts of paper currency in China, ship it to Japan to be recycled into paper, and make a substantial profit. Under these circumstances, was the Chinese paper currency a commodity money LOADING... or a fiat money LOADING... ?
It is a commodity money because it has value as recycled paper.
During the Civil War, the Confederate States of America printed lots of its own currencylong dash—Confederate dollarslong dash—to fund the war. By the end of the war, nearly 1.5 billion paper dollars had been printed by the Confederate government. Source: "Textual Transcript of Confederate Currency," Federal Reserve Bank of Richmond. How would such a large quantity of Confederate dollars have affected the value of the Confederate currency?
It would have generated high inflation and therefore decreased the value of the Confederate currency.
What are the largest asset and the largest liability of a typical bank?
Loans are the largest asset and deposits are the largest liability of a typical bank.
In a speech delivered in June 2008, Timothy Geithner, then president of the Federal Reserve Bank of New York and later U.S. Treasury secretary, said: The structure of the financial system changed fundamentally during the boom. . . . [The] non-bank financial system grew to be very large. . . . [The] institutions in this parallel financial system [are] vulnerable to a classic type of run, but without the protections such as deposit insurance that the banking system has in place to reduce such risks. Source: Timothy F. Geithner, "Reducing Systemic Risk in a Dynamic Financial System," Remarks at the Economics Club of New York, June 9, 2008. a. What did Geithner mean by the "non-bank financial system"? b. What is a "classic type of run"? c. Why would deposit insurance provide the banking system with protection against runs?
Money market mutual funds, hedge funds, and other financial firms that raise money from investors and provide it to firms and households. Many depositors simultaneously decide to withdraw their money from a bank. Since most depositors are insured, it is less likely that panicked buyers will simultaneously withdraw funds.
Which one of the following is not one of the policy tools the Fed uses to control the money supply? Which tool is the most important?
Moral suasion. The Fed conducts monetary policy principally through open market operations.
Which one of the following is not one of the policy tools the Fed uses to control the money supply? Which tool is the most important?
Moral suasion. The Fed conducts monetary policy principally through open market operations.
The English economist William Stanley Jevons described a world tour during the 1880s by a French singer, Mademoiselle Zelie. One stop on the tour was a theater in the Society Islands, part of French Polynesia in the South Pacific. She performed for her usual fee, which was one-third of the receipts. This turned out to be three pigs, 23 turkeys, 44 chickens, 5000 coconuts, and "considerable quantities of bananas, lemons, and oranges." She estimated that all of this would have had a value in France of 4000 francs. According to Jevons, "as Mademoiselle could not consume any considerable portion of the receipts herself, it became necessary in the meantime to feed the pigs and poultry with the fruit." Source: W. Stanley Jevons, Money and the Mechanism of Exchange, New York: D. Appleton and Company, 1889, pp. 1-2. Do the goods Mademoiselle Zelie received as payment fulfill the four functions of money LOADING... ?
No. The goods are not a store of value.
Which one of the following is not a function of money?
Open market operation. If something is to be considered as money, it has to fulfill all four functions
The formula for the simple deposit multiplier is If the required reserve ratio is 0.15, the maximum increase in checking account deposits that will result from an increase in bank reserves of $15,000 is
Simple Deposit Multiplier = 1/RR $100,000
The text explains that the United States has a "fractional reserve banking system LOADING... ." Why do most depositors seem to be unworried that banks loan out most of the deposits they receive?
The FDIC insures deposits up to $250,000.
The U.S. penny is made primarily of zinc. There have been several times in recent years when zinc prices have been high and it has cost the U.S. Treasury more than one cent to manufacture a penny. There are currently about 1.4 billion pennies in circulation. Economist François Velde of the Federal Reserve Bank of Chicago has proposed making the current penny worth 5 cents. Source: Austan Goolsbee, "Now That a Penny Isn't Worth Much, It's Time to Make It Worth 5 Cents," New York Times, February 1, 2007. Is this change likely to have much impact on the economy?
The effect of this proposal would cause an increase in the value of M1. No
According to the quantity theory of money LOADING... , inflation results from which of the following?
The money supply grows faster than real GDP.
When the Federal Reserve decreases the required reserve ratio commadecreases the required reserve ratio,
The money supply will increase.
Suppose that during one period, the velocity of money is constant and during another period, it undergoes large fluctuations. During which period will the quantity theory of money be more useful in explaining changes in the inflation rate?
The period where velocity is constant because when velocity is constant the changes in the money supply can be shown to be the main cause of inflation.
The following is from an article on community banks: "Their commercial-lending businesses, funded by their stable deposit bases, make them steady earners." Source: Karen Richardson,"Clean Books Bolster Traditional Lenders," Wall Street Journal, April 30, 2007, p. C1. What is commercial lending? We can say that loans are funded by deposits because deposits give banks financial capital, which can be loaned out so banks can make a profit.
This is when banks make loans to businesses. True
How do the banks "create money"?
When there is an increase in checking account deposits, banks gain reserves and make new loans, and the money supply expands.
The paper currency of the United States is technically called "Federal Reserve Notes." The following excerpt is from the Federal Reserve Act: "Federal Reserve Notes...shall be redeemed in lawful money on demand at the Treasury Department of the United States, in the city of Washington, District of Columbia, or at any other Federal Reserve bank." If you took a $20 bill to the Treasury Department or Federal Reserve bank, with what type of "lawful money" is the government likely to redeem it?
With another Reserve Note of equal value.
Would a series of bank runs LOADING... in a country decrease the total quantity of M1? Wouldn't a bank run simply move funds from a checking account to currency in circulation?
Yes A bank run reduces bank reserves and therefore reduces the number of loans a bank makes. This lowers checking balances beyond the amount currency increases and reduces the quantity of money.
Suppose that you are a bank manager, and the Federal Reserve raises the required reserve ratio LOADING... from 10 percent to 12 percent. What actions would you need to take?
You would have to reduce loans to make up for the necessary increase in reserves. As your actions and those of other bank managers reduced the amount of loans made, we would expect that the money supply would end up decreasing .
Suppose that you are a bank manager, and the Federal Reserve raises the required reserve ratio LOADING... from 10 percent to 12 percent. What actions would you need to take?
You would have to reduce loans to make up for the necessary increase in reserves. As your actions and those of other bank managers reduced the amount of loans made, we would expect that the money supply would end up decreasing .
Suppose you decide to withdraw $100 in cash from your checking account. Which one of the following choices accurately shows the effect of this transaction on your bank's balance sheet.
Your bank's balance sheet shows a decrease in reserves by $100 and a decrease in deposits by $100.
An article in the New York Times provides the following description of a hospital in Zimbabwe: "People lined up on the veranda of the American mission hospital here from miles around to barter for doctor visits and medicines, clutching scrawny chickens, squirming goats and buckets of maize." Source: Celia W. Dugger, "Zimbabwe Health Care, Paid With Peanuts," New York Times, December 18, 2011. The people buying medical services at this hospital could not use money to pay for the medical services they were buying because the
Zimbabwean currency was worthless.
Look carefully at the following list. a. The coins in your pocket. b. The funds in your checking account. c. The funds in your savings account. d. The traveler's check that you have left over from a trip. e. Your Citibank Platinum MasterCard. Which of the things above are NOT included in the M1 LOADING... definition of the money supply?
c & e
Congress passed legislation to create the Federal Reserve System in 1913 in order to The most important role of the Federal Reserve in today's U.S. economy is
end the instability created by bank panics by acting as a lender of last resort. controlling the money supply to pursue economic objectives.
Very high rates of inflation are called Governments sometimes allow hyperinflation to occur because
hyperinflation. when governments want to spend more than they collect in taxes, central banks increase the money supply at a rate higher than GDP growth, often resulting in hyperinflation.
The real-world money multiplier
is smaller than the simple deposit multiplier because banks keep excess reserves and households hold excess cash.
According to Peter Heather, a historian at King's College London, during the Roman Empire, the German tribes east of the Rhine River produced no coins of their own but used Roman coins instead: "Although no coinage was produced in Germania, Roman coins were in plentiful circulation and could easily have provided a medium of exchange (already in the first century, Tacitus tells us, Germani of the Rhine region were using good-quality Roman silver coins for this purpose)." Source: Peter Heather, The Fall of the Roman Empire: A New History of Rome and the Barbarians, New York:Oxford University Press, 2006, p. 89. When sellers are willing to accept money in exchange for goods and services, money is acting as a If some of the Roman coins had been taken to Germania, then the coins could have been a medium of exchange in Germania if people began to consider it safe and would have accepted it for payments. If coins could have been easily used to purchase goods and services in other areas, the coins would also have some intrinsic value.
medium of exchange. True
Which one of the following is not a reason why businesses accept paper currency knowing that, unlike a gold coin, the paper the currency is printed on is worth very little? Paper currency is a good medium of exchange because it is
not valuable.
A baseball fan with a Mike Trout baseball card wants to trade it for a Miguel Cabrera baseball card, but everyone the fan knows who has a Cabrera card doesn't want a Trout card. Economists characterize this problem as a failure of the
principle of a double coincidence of wants.
When the Federal Reserve purchases Treasury securities in the open market, When the Federal Reserve sells Treasury securities in the open market,
the sellers of such securities deposit the funds in their banks and bank reserves increase. the buyers of these securities pay for them with checks and bank reserves fall.
During the German hyperinflation of the 1920s, many households and firms in Germany were hurt economically; however, people with debt actually benefited some from the hyperinflation.
true
A New York Times article on Zimbabwe describes conditions in summer 2008 as follows: "Official inflation soared to 2.2 million percent in Zimbabwelong dash—by far the highest in the world . . . [and] unemployment has reached 80 percent." Source: "Inflation Soars to 2 Million Percent in Zimbabwe," New York Times, July 17, 2008. Is it likely that Zimbabwe's high rates of inflation and unemployment are connected?
Yes, because with high inflation and little purchasing power, output is likely to fall, and unemployment will rise.
In the nineteenth century, the Canadian government had difficulty getting banks and the public to accept the penny, which had been introduced a few years before. As a result, the government offered pennies for sale at a 20 percent discount. One account of this episode describes what the Canadian government did as "negative seigniorage." Source: Nicholas Kohler, "A Penny Dropped," macleans.ca, January 14, 2011. Seigniorage is the The Canadian government's selling pennies at a 20 percent discount could be considered as
government's profit from issuing fiat money. "negative seigniorage" because the cost of producing pennies was higher than its face-value.
