Chapter 14 - Money, Banking, and Financial Institutions
How many Federal Reserve Banks are there?
12
If the required reserve ratio is 50 percent, what is the monetary multiplier? If the monetary multiplier is 20, what is the required reserve ratio?
2 5 If the required reserve ratio is 50 percent, what is the monetary multiplier? The monetary multiplier equals one divided by the required reserve ratio. The monetary multiplier = 1 / Required reserve ratio = 1/.5 = 2 If the monetary multiplier is 20, what is the required reserve ratio? We can rearrange this question to solve for the required reserve ratio when given the monetary multiplier. Required reserve ratio = 1 / Monetary multiplier = 1/20 =.05 (or 5%)
Suppose that Serendipity Bank has excess reserves of $8,000 and checkable deposits of $150,000. If the reserve ratio is 10 percent, what is the size of the bank's actual reserves?
23,000 The first step is to calculate the required reserves for the bank, which equals the product of the required reserve ratio (decimal form) and checkable deposits.Required reserves = 0.1 x $150,000 = $15,000 The second step is to calculate actual reserves, which is the sum of required reserves and excess reserves.Actual reserves = Required reserves + Excess reserves = $15,000 + $8,000 = $23,000
Assume that Jimmy Cash has $3100 in his checking account at Folsom Bank and uses his checking account card to withdraw $310 of cash from the bank's ATM machine. By what dollar amount did the M1 money supply change as a result of this single, isolated transaction?
$0 The answer is zero. Jimmy withdrew $310 from his checking account, so his checkable deposits are now $2,790. This results in a decrease in M1 by the amount of the withdrawal. However, Jimmy now has $310 in cash, which increases M1 by $310. The net effect of this transaction is zero.
what does M2 consist of?
-savings, including money market deposits - money market mutual funds - small denominated time deposits -M1
Third National Bank has reserves of $20,000 and checkable deposits of $100,000. The reserve ratio is 20 percent. Households deposit $5,000 in currency into a checking account at the bank and that currency is added to reserves. What level of excess reserves does the bank now have?
4,000 The first step is to calculate checkable deposits. This equals the original checkable deposits plus the new deposit, $105,000 (= $100,000 + $5,000). The second step is to calculate required reserves for the deposits, which equals the product of the required reserve ratio (decimal form) and checkable deposits.Required reserves = 0.2 x $105,000 = $21,000 The third step is to calculate excess reserves, which equals actual reserves minus required reserves. Since the $5,000 deposit was added to the original reserves of $20,000, the new (actual) reserves equal $25,000.Excess reserves = Actual reserves - Required reserves = $25,000 - $21,000 = $4,000
How many board of governors are there?
7
What are the three basic functions of money?
A medium of exchange, a unit of account, and store of value
Who decides monetary policy?
Federal Open Market Committee
Which of the following are included in the functions of the Federal Reserve System?
Issuing Federal Reserve Notes, providing for check collection, and supervising the operation of banks
what is the narrowest definition of the U.S money supply?
M1
Excess reserves are equal to
actual reserves minus required reserves.
checkable deposits
all deposits in commerical banks and "thrift" or savings institutions on which checks of any size can be drawn.
Subprime mortgage loans were one of the factors that exacerbated the financial crisis of 2007-2008 because they resulted in
an increase in demand for housing and a rapid increase in home prices that was unsustainable.
central bank
an institution designed to oversee the banking system and regulate the quantity of money in the economy
Excess reserves
can be lent out, increasing the money supply.
The major claims on a commercial bank's balance sheet are
checkable deposits
which financial institutions offer checkable deposits included within the M1 money supply
commercial banks and thrift instiutions
The major categories of firms that make up the U.S. financial services industry include
commercial banks, thrifts, insurance companies, and securities related firms.
what are two kinds of money?
commodity money (gold coins) and fiat money (the U.S dollar)
what is the fed's major goal?
control of the money supply
long term bonds
high risk
When economists say that the Federal Reserve Banks are bankers' banks, this means th
they perform the same functions for banks as banks perform for the public.
what is a second and broader definition of money?
this definition includes M1 plus several near monies. Near monies are certain highly liquid financial assets that do not function directly or fully as a medium of exchange but can be readily converted into currency or checkable deposits.
How can banks create money?
through lending
what is the purpose of the open market operations?
to control the nations money supply and influence interest rates
TARP is the
troubled Asset Relief Program funded with general tax revenue and the issuance of government debt.
The Federal Open Market Committee (FOMC)
votes on the Fed's monetary policy and directs the purchase or sale of government securities.
Suppose the price level and value of the U.S. dollar in year 1 are 1 and $1, respectively. If the price level rises to 1.45 in year 2, what is the new value of the dollar? If, instead, the price level falls to 0.45, what is the value of the dollar?
0.70 2.22 The amount a dollar will buy varies inversely with the price level; that is, a reciprocal relationship exists between the general price level and the purchasing power of the dollar. That is, to find the value of the dollar $V, divide 1 by the price level P expressed as an index number (in hundredths).In equation form, the relationship looks like this: $V = 1/P.This implies that when the price level rises to 1.45 in year 2, the new value of the dollar is $V = 1/1.45 = $0.69.This also implies that when the price level falls to 0.45, the new value of the dollar is $V = 1/0.45 = $2.22.
What is the monetary multiplier?
1 / reserve ratio
The Federal Reserve performs seven basic functions:
1. The Fed issues Federal Reserve Notes, the paper currency used in the U.S. monetary system. 2. The Fed sets reserve requirements and holds the mandated reserves that are not held as vault cash. 3. The Fed lends money to banks and thrifts. 4. The Fed provides for check collection. 5. The Fed acts as fiscal agent for the federal government. 6. The Fed supervises the operation of banks. 7. Finally, and most importantly, the Fed has responsibility for regulating the supply of money, and this in turn enables it to affect interest rates.
The chairperson of the Federal Reserve Board is selected by the
U.S. president and confirmed by the Senate
fractional reserve banking
does not hold all the money money can be created creates money through lending banks are subject to panics
the U.S president, with confirmation of the senate...
appoints the seven board members. - terms are 14 years and staggered so that one member is replaced every 2 years. - those officers serve 4 year terms and can be reappointed to new 4 year terms by the president
Net worth is equal to
assets minus liabilities
A balance sheet must always balance because the sum of
assets must equal the sum of liabilities plus net worth.
who is the central authority of the U.S money and banking system?
board of governors of the FRS
The Federal Reserve Board of Governors
coordinates policies for the 12 Federal Reserve Banks.
what does M1 consist of?
currency + checkable deposits
which is not included in M1 or M2?
currency held by banks
Compared to a decade ago, there are
fewer bank firms.
Government loans create moral hazard because there is a tendency
for financial services firms to take on greater risks because they assume they are at least partially insured against losses.
financial system
group of institutions in the economy that help match the savings of one person with the investment of another
mutual funds
institutions that sell shares to the public and use the proceeds to buy portfolios of stocks and bonds
Financial Institution
institutions through which savers can directly provide funds to borrowers financial markets.
financial intermediaries
instiutions through which savers can indirectly provide funds to borrowers
The purchasing power of the dollar is
inversely related to the price level.
The monetary multiplier is
inversely related to the reserve ratio.
American International Group (AIG) exacerbated the financial crisis of 2007-2008 by
issuing billions of dollars of collateralized default swaps that had embedded mortgage-loan risk.
short term bonds
low risk
A single commercial bank can safely lend only an amount equal to its excess reserves, but the commercial banking system can lend by a multiple of its excess reserves because
one bank loses reserves to other banks, but the system does not.
An asset on a bank's balance sheet is something
owned by the bank, whereas a liability is something owed by the bank.
what are fractional reserves vulnerable to?
panics or runs
Rapid inflation can undermine money's ability to perform its functions. For example, in runaway inflation
people revert to barter because money fails as a medium of exchange.
Mortgage backed securities were one of the factors that exacerbated the financial crisis of 2007-2008 because they
reduced the risk exposure, or cost, that banks faced after issuing these subprime loans, and encouraged this type of lending.
The Federal Reserve requires that commercial banks have reserves because
reserves provide the Fed a means of controlling the money supply.
The major assets on a commercial bank's balance sheet include
reserves, securities, loans, and vault cash.
The categories of financial firms have become more blurred as these firms are trying to
retain their market share.
financial markets
savers can directly provide funds to borrowers
The Federal Open Market Committee (FOMC) includes
the Board of Governors members and 5 of the 12 presidents of the Federal Reserve Banks, of which the president of the New York Fed has a permanent voting seat.
Federal Reserve System
the central bank of the United States
what is an asset's liquidity?
the ease with which it can be converted into the most widely accepted and easily spent form of money-cash with little or no loss of purchasing power.
When economists say that the Federal Reserve Banks are central banks, this means that
the policies are coordinated by the Federal Reserve Board of Governors.
When economists say that the Federal Reserve Banks are quasi-public banks, this means that
they are a blend of private ownership and public control.
by excluding currency held by banks when determining the total supply of money....
we avoid the problem of double counting
mortage-backed securities
when banks bundle hundreds or thousands of mortages and sell them as bonds
The financial crisis of 2007-2008 was exacerbated by subprime mortgage loans. These loans were made to borrowers
who were more likely to default on their loans.
