Eco Chapter 13

The nature and measurement of the money supply has become more difficult in recent years because of

financial innovations, such as the introduction of interest-earning checking accounts and money market mutual funds.

When a banker accepts a deposit of $1,000 in cash and puts $200 aside as required reserves and then makes a loan of $800 to a new borrower, this set of transactions

increases money supply by $800

The legal requirement that commercial banks hold reserves equal to some fraction of their deposits

limits the ability of banks to expand the money supply by extending additional loans.

The three basic functions of money are

medium of exchange, store of value, unit of account

Fiat money is defined as

money that has little intrinsic value; it is neither backed by nor convertible to a commodity of value.

The tool used most frequently by the Fed to control the money supply is

open market operations.

During the economic crisis of 2008, the Fed acquired the authority to

pay interest to commercial banks on their reserves.

If money were not used as a medium of exchange,

the gains from trade would be severely limited.

If the banking system has $50 billion in excess reserves, and the required reserve ratio is 25 percent, what is the maximum amount by which the money supply can be increased?

$200 billion

If the public decides to hold more currency and fewer deposits in banks, bank reserves

decrease and the money supply eventually decreases.

If the Fed wanted to expand the money supply as part of an antirecession strategy, it could

decrease the interest rate paid on excess reserves encouraging banks to extend more loans.

If the Federal Reserve wanted to expand the supply of money to head off a recession, it could

decrease the reserve requirements

The main source of profit for financial institutions is

the difference between interest paid on deposits and interest received on loans.

The primary source of earnings of commercial banks is income derived from

the use of deposits to extend loans and undertake investments.

If the Fed wants to shift toward a more expansionary policy, it often announces that it is going to change the federal funds interest rate. The Fed controls the federal funds interest rate

through its policy of open market operations.

Compared to a barter economy, using money increases efficiency by reducing

transaction costs

As the Fed increased its asset holdings and the volume of loans to financial institutions during the latter half of 2008, the result was

a vast increase in the monetary base and in the excess reserves of the commercial banking system.

When economists say that money serves as a unit of account, they mean that money

allows people to value all goods and services in terms of one commodity (money), rather than in terms of several commodities

Which of the following would cause the money supply in the United States to expand? (a) A decrease in reserve requirements. (b) An increase in the discount rate. (c) The sale of bonds by a Federal Reserve bank. (d) An increase in the world supply of gold.

(a) A decrease in reserve requirements.

Which of the following would be most appropriate if the Federal Reserve wanted to increase the money supply in order to stimulate the economy? (a) Buy U.S. securities. (b) Force the Treasury to reduce the national debt. (c) Rraise the discount rate. (d) Increase the reserve requirements.

(a) buy US securities

In the United States, the control of the money supply is the responsibility of the

Federal Reserve System (the Fed).

If the Fed injects additional reserves into the banking system, why will banks generally want to expand their loans and investments?

Loans and investments generally earn more interest income for the banks than excess reserves.

Suppose the U.S. Treasury issues and sells $100 million of U.S. government securities (bonds) to the public.

The money supply will be unaffected; the national debt will increase.

Suppose the Fed sells $100 million of U.S. government securities (bonds) to the public. How will this affect the money supply and the national debt?

The money supply will decrease; the national debt will be unaffected

The federal funds rate is the interest rate

banks pay when they borrow money from each other for short periods of time.

If the Fed lends to member banks, what happens to reserves and the money supply?

both increase

If the Fed wanted to shift to a restrictive monetary policy and reduce the money supply, it could

increase the interest rate paid on excess reserves encouraging banks to hold excess reserves rather than extend more loans.

The value (purchasing power) of each unit of money

is inversely related to prices (in other words, money's value falls as prices rise and vice versa).

The value (purchasing power) of each unit of money

is inversely related to the general level of prices

Though many assets can be used as a store of value, money is a particularly attractive method to store value because

it is the most liquid of all assets

The total expansion in the money supply can be less than is predicted by the deposit expansion multiplier if

(1) banks choose to hold some excess reserves rather than lending all excess reserves. (2) some individuals prefer to hold cash instead of depositing their money in banks. c

Which of the following lists two things that both decrease the money supply? (a) Raise the discount rate and make open market purchases. (b) Raise the discount rate and make open market sales. (c) Lower the discount rate and make open market purchases. (d) Lower the discount rate and make open market sales.

(b) Raise the discount rate and make open market sales.

Which of the following correctly indicates how the Fed could use the interest rate it pays commercial banks on their excess reserves to influence the money supply? a. If the Fed wanted to increase the money supply, it could increase the interest rate it pays banks on their excess reserves. b. When the Fed reduces the interest rate paid on excess reserves, it increases the incentive of commercial banks to hold excess reserves. c. If the Fed wanted to decrease the money supply, it could increase the interest rate paid on excess reserves. d. When the Fed increases the interest rate it pays on excess reserves, this encourages banks to extend more loans and thereby increase the money supply.

(c) If the Fed wanted to decrease the money supply, it could increase the interest rate paid on excess reserves.

Suppose a bank receives a new deposit of $500. The bank extends a new loan of $400 because it is required to hold the other $100 on reserve. What is the legal required reserve ratio?

20%

A reserve requirement of 20 percent implies a potential money deposit multiplier of

5

What is meant by the expression, "There is too much money chasing too few goods"?

An expansion in the supply of money relative to the availability of goods and services is causing an increase in the general level of prices.

You withdraw $100 from your checking account. How does this affect the money supply and the reserves of your bank?

There is no change in the money supply, and the reserves of your bank decline.

Suppose the Fed buys $10 million of U.S. securities from the public. Assume a reserve requirement of 5 percent and that all banks hold no excess reserves. The total impact of this action on the money supply will be

an increase of $200 million.

Rather than using the purchase and sale of only government bonds in the conduct of open market operations, in 2008 the Fed also began buying and selling

corporate bonds, commercial paper, and mortgage-backed securities from commercial banks and other financial institutions

The primary benefit of a monetary system of exchange compared to a barter system is the increased

efficiency in arranging transactions.

The difference between the total reserves that a bank holds and the amount that is required by law are

excess reserves

When reserve requirements are increased, the

excess reserves of commercial banks will decrease.

If many people were to suddenly deposit into their checking accounts large sums of cash previously held in their homes and/or wallets, and there were no offsetting actions by the Fed or change in institutional policies, this would

increase the excess reserves of banks and expand the money supply if these reserves are used to make additional loans.

If uncertainty causes commercial banks to increase their holdings of excess reserves, other things constant, this will

reduce the size of the deposit expansion multiplier.

If the Fed wants to use "open market operations" to decrease the money supply, it would

sell U.S. government securities (bonds) to the general public.

The larger the reserve requirement, the

smaller the deposit expansion multiplier