Chapter 14 Macroeconomics
A bank's reserve ratio is 10% and the bank has $5,000 in deposits. Its reserves amount to A.) $50 B.) $500 C.) $4,500 D.) $4,950
$500
The reserve requirement is 12%. Lucy deposits $600 into a bank. By how much do excess reserves change? A.) $600 B.) $528 C.) $72 D.) $12
$528
What does the Fed do to *decrease* the money supply?
*Sells* its securities
In order to serve as an acceptable medium of exchange, a good should have the following characteristics:
1. Acceptable to most people 2. Standardized quality so any two units are alike 3. Durable so that value is not lost by storage 4. Valuable relative to its weight, so that it can easily be transported even in large quantities 5. Divisible because different goods are valued differently
Money fulfills four primary functions:
1. Medium of Exchange 2. Unit of Account 3. Store of Value 4. Standard of Deferred Payment
The Fed has three monetary policy tools at its disposal:
1. Open Market Operations (Most Common) 2. Discount Policy 3. Reserve requirements
What is the relationship between banks and the money supply?
1. When banks *gain* reserves, they make new loans, and the money supply *expands.* 2. When banks *lose* reserves, they reduce their loans, and the money supply *contracts.*
How make Federal Reserve Districts are there?
12
If the reserve ratio is 15%, the money multiplier is A.) 7.7 B.) 6.7 C.) 5.7 D.) 15
6.7
If M=2,000, P=2.25, and Y=6,000, what is velocity? A.) 6.75 B.) 3.00 C.) 1.33 D.) 1.50
6.75 V=P*Y So, V= P*Y/M=2.25*6000/2000=6.75
Who issues paper money?
A central bank run by the government
How can the Federal Reserve prevent bank runs and panics?
Acting as a lender of last resort, promising to make loans to banks in order to pay off depositors.
Which of the following is a function of money? A.) A unit of account B.) A store of value C.) Medium of exchange D.) All of the above
All of the above
Anything of value owned by a person or a firm.
Asset
On a balance sheet, assets and liabilities are listed on what side?
Assets are listed on the left, and liabilities are listed on the right. The two sides must add up to the same amount.
Many banks simultaneously experience bank runs
Bank Panic
Depositors lose confidence in a bank, and try to withdraw their money all at once
Bank Run
What plays a critical role in the money supply?
Banks (profit-making private firms)
What is under assets?
Banks loans and their bought securities (investments)
When the Fed decreases the discount rate, banks will a.) borrow more from the Fed and lend more to the public. The money supply increases. b.) borrow more from the Fed and lend less to the public. The money supply decreases. c.) borrow less from the Fed and lend more to the public. The money supply increases. d.) borrow less from the Fed and lend less to the public. The money supply decreases.
Borrow more form the Fed and lend more to the public. The money supply increases
How do banks make a profit?
By lending out or investing money deposited with it
What is an advantage of fiat money?
Central banks are more flexible in creating money
Goods used as money that also have value independent of their use as money
Commodity Money
Which of the following is *not* included in M1? A.) Currency B.) Demand Deposits C.) Traveler's Checks D.) Credit Cards
Credit Cards
An open-market sale a.) increases the number of dollars and the number of bonds in the hands of the public. b.) increases the number of dollars in the hands of the public and decreases the number of bonds in the hands of the public. c.) decreases the number of dollars and the number of bonds in the hands of the public. d.) decreases the number of dollars in the hands of the public and increases the number of bonds in the hands of the public.
Decreases the number of dollars in the hands of the public and increases the number of bonds in the hands of the public
What does the Fed do to *increase* the money supply?
Directs its trading desk to *buy* treasury securities
The Fed makes loans to banks
Discount Loans
The fed makes loans to banks and charges a rate of interest
Discount Rate
According to the quantity equation, the price level would change less than proportionately with a rise in the money supply if there were also a.) either a rise in output or a rise in velocity. b.) either a rise in output or a fall in velocity. c.) either a fall in output or a rise in velocity. d.) either a fall in output or a fall in velocity.
Either a rise in output or a fall in velocity
When we want to talk about the money supply, which definition should we use?
Either one might be valid, but we are mostly interested in money's role as the medium of exchange, so this suggests using *M1*
Reserves over the legal requirement
Excess Reserves
Central bank of the United States
Federal Reserve
An *increase* in the required reserve ratio would result in what?
Fewer loans being made
Any money, such as paper currency, that is authorized by a central bank or governmental body, and that does not have to be exchanged by the central bank for gold or some other commodity money.
Fiat Money
Banks keep less than 100% of deposits as reserves
Fractional Reserve Banking System
Funds that *raise* money from wealthy investors and make "sophisticated" (often non-standard) investments
Hedge Funds
What is a disadvantage of fiat money?
If people stop "believing" in the fiat money, it will cease to be useful
Suppose the money supply grew at an average annual rate of 8%, velocity was constant, the nominal interest rate averaged 9%, and output grew at an average annual rate of 3%. According to the Quantity Theory, a.) inflation averaged 8% per year and the real rate of return was 9%. b.) inflation averaged 11% per year and the real rate of return was 17%. c.) inflation averaged 5% per year and the real rate of return was 4%. d.) inflation averaged 1% per year and the real rate of return was 6%.
Inflation averaged 5% per year and the real rate of return was 4%. M*V=P*Y Using a bit of math, we can show, % change in M+% change in V=% change in P+% change in Y Since V is constant, % change in V=0. % change in M=8, % change in Y=3 Therefore, % change in P=% change in M-% change in Y=8-3=5% We also know, Real Interest Rate = Nominal Interest Rate - Inflation Rate = 9-5=4%
Banks that do *not* typically accept deposits from or make loans to households; they provide investment *advice*, and engage in creating and trading securities such as mortgage-backed securities
Investment Banks
What does the Fed do by *lowering* the discount rate?
It encourages banks to borrow (or lend out) more money, *increasing* money supply
What does the Federal Deposit Insurance Corporation (FDIC) do?
It insures deposits in many banks up to a limit
Which of the following is an asset of a bank and a liability for its customers? a.) deposits of its customers and loans to its customers b.) deposits of its customers but not loans to its customers c.) loans to its customers but not the deposits of its customers d.) neither the deposits of its customers nor the loans to its customers
Loans to its customers but not the deposits of its customers
The narrowest definition of the money supply: the sum of currency in circulation, checking account deposits in banks, and holdings of traveler's checks
M1
Derek decides to forego a major appliance purchase and save the money. He transfers $2,100 from his checking account to his money market mutual fund. As a result of this transfer, a.) both M1 and M2 decrease by $2,100. b.) M1 increases by $2,100 and M2 increases by $2,100. c.) M1 decreases by $2,100 and M2 increases by $2,100. d.) M1 decreases by $2,100 and M2 stays the same.
M1 decreases by $2,100 and M2 stays the same
Given the following information, what are the values of M1 and M2? Small time deposits $2,200 billion Demand deposits and other checkable deposits $1,700 billion Savings deposits $2,600 billion Money market mutual funds $1,500 billion Traveler's checks $60 billion Large time deposits $1,500 billion Currency $350 billion Miscellaneous categories in M2 $75 billion a.) M1 = $4,310 billion, M2 = $6,285 billion. b.) M1 = $2,050 billion, M2 = $9,985 billion. c.) M1 = $2,110 billion, M2 = $8,485 billion. d.) M1 = $3,610 billion, M2 = $9,985 billion.
M1=$2,100 billion, M2=$8,485 billion M1= Currency+ Traveler's checks+ Demand deposits and other checkable deposits = 1700+60+350=2110 M2= M1+ Small time deposits+ Savings deposits+ Money market mutual funds+ Miscellaneous categories in M2 + (NOT LARGE TIME DEPOSITS) = 2110+2200+2600+1500+75=8485
A broader definition of the money supply: it includes M1, plus savings account balances, small-denomination time deposits, balances in money market deposit accounts, and non-institutional money market fund shares
M2
Money is acceptable to a wide variety of parties as a form of payment for goods and services
Medium of Exchange
You receive money as payment for babysitting your neighbors' children. This best illustrates which function of money? a.) medium of exchange b.) unit of account c.) store of value d.) liquidity
Medium of exchange
The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives.
Monetary Policy
An asset that people are generally willing to accept in exchange for goods and services, or for payments of debt.
Money
Funds that *sell* shares to investors and use the money to *buy* short term treasury bills and commercial paper (loans to corporations)
Money Market Mutual Funds
A *decrease* in the required reserve ratio would result in what?
More loans being made, *increasing* money supply
Is velocity truly constant from year to year?
No
Do credit and debit cards represent money?
No: debit cards are considered the checking account balance
The buying and selling of Treasury securities by the Federal Reserve in order to control the money supply
Open Market Operations
MxV=PxY
Quantity Equation
A theory about the connection between money and prices that assumes that the velocity of money is constant
Quantity Theory of Money
The minimum fraction (10%) of deposits banks are required by law to keep as reserves
Required Reserve Ratio (RR)
Reserves that a bank is legally required to hold, based on its checking account deposits
Required Reserves
Deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve
Reserves
The process of transforming loans or other other financial assets into securities
Securitization
Secondary markets, allowing securities to be traded
Securitized loans
A financial asset-such as a stock or a bond-that can be bought and sold in a financial market
Security
The ratio of the amount of deposits created by banks to the amount of new reserves 1/RR Change in checking account deposits=change in bank reserves x 1/RR
Simple Deposit Multiplier
Money facilitates exchanges across time when we anticipate that its value in the future will be predictable
Standard of Deferred Payment
Money allows people to defer consumption till a later date by storing value. Other assets can do this too, but money does it particularly well because it is liquid, easily exchanged for goods.
Store of Value
Who conducts America's monetary policy?
The Federal Open Market Committee (FOMC)
Inflation Rate=Growth rate of the money supply-growth rate of real output
The inflation rate according to the quantity theory
What is the discount rate?
The interest rate paid on money banks borrow from the Fed
When the Fed sells government bonds, a.) the money supply increases and the federal funds rate increases. b.) the money supply increases and the federal funds rate decreases. c.) the money supply decreases and the federal funds rate increases. d.) the money supply decreases and the federal funds rate decreases.
The money supply decreases and the federal funds rate increases
What is the largest liability?
Their deposit accounts: money they owe to their depositors
Economists use the world "money" to refer to a.) income generated by the production of goods and services. b.) those assets regularly used to buy goods and services. c.) financial assets such as stocks and bonds. d.) any type of wealth.
Those assets regularly used to buy goods and services
What is the primary role of commercial banks?
To accept funds from depositors and make loans to borrowers
Which of the following is *not* included in either M1 or M2? A.) U.S. Treasury Bills B.) Small Time Deposits C.) Demand Deposits D.) Money Market Mutual Funds
U.S. Treasury Bills
Money allows a way of measuring value in a standard manner
Unit of Account
The average number of times each dollar in the money supply is used to purchase goods and services included in GDP
Velocity of Money
Suppose a bank is operating with a leverage rate of 10. A 6% increases in the value of assets a.) will reduce liabilities by 6 percent. b.) will result in a 60 percent increase in owner's equity. c.) will result in a 60percent decrease in owner's equity. d.) will reduce liabilities by 10 percent.
Will result in a 60% increase in owner's equity Assume the bank has assets worth $100. The leverage ratio is 10. We know, LR=assets/Capital. Therefore, Bank's capital = 100/10=10. When assets value increase by 6%, the value of the assets are now 106. Increased value of the assets will become new capital of the bank. Therefore, the new capital of the bank is = 10+6=16. Therefore, the equity or the capital of the bank increase by {(16-10)/10}*100=60%
