Ch. 5 Money & Banking

If the federal reserve bank conducts an open-market operation and purchases $20m worth of government bonds and the required deposit ratio is 20%, the largest possible increase in the money supply that could result is $___Million

$100M; The $20M purchase of government bonds bythe Federal Reserve Bank increases the currency circulating in the economy by $20M. If all of that currency is deposited into checking accounts and if banks keep no excess reserves, ceteris paribus, then the largest possible increase in the money supply that could result is $100M. To get this number divide $20M by 20% reserve deposit ratio. You don't include the assets already in circulation here

If the Federal Reserve Bank conducts an open-market operation and auctions of $10M worth of govt bonds, and the reserve ratio is 20%, the smallest possible decrease in the money supply that could result is $___M

$10M; If all of that currency was never deposited into the banking system, ceteris paribus, then the money supply only decreases by $10M- the exact amount of currency taken out of circulation

If the federal reserve bank conducts an open-market operation and purchases $20m worth of government bonds and the required deposit ratio is 20%, the smallest possible increase in the money supply that could result is $___Million

$20M; If all of the $20M worth of currency is not deposited into the banking system ceteris paribus, then the money supply only increases by $20M - the exact amount of currency placed into circulation

If the Federal Reserve Bank conducts an open-market operation and auctions of $10M worth of govt bonds, and the reserve ratio is 20%, the largest possible decrease in the money supply that could result is $___M

$50M; If all currency had been deposited into checking accounts, and if the banks kept no excess reserves, ceteris paribus, then the largest possible decrease in the money supply that could result is $50M. To get this number divide $10M bu 20% reserve deposit ratio

classifications of money supply

(1) M1, (2) M2)

Types of Money

(1) commodity money (2) flat money

Three basic functions of money

(1)medium of exchange (2)a store of value, (3) unit of account

Three tools fo central bank for monetary policy

(1)open market operations, (2) reserve requirement changes, and (3) changes to the Federal Reserve's discount rate

federal reserve

12 regional banks and board in DC

federal reserve board members

14 yr term; appointed by president and confirmed by the senate

FOMC

7 members of the board of governors, 5 of the 12 regional bank presidents; all 12 are present but only 5 vote; voting right rotate except the NY president always votes

the value of one unit of money

=1/price level (ex. price level = 5; 1/5=.2)

reserve-deposit ratio

=bank reserves/checkable deposits

current reserve-deposit ratio

=bank reserves/checkable deposits;

checkable deposits

=bank reserves/desired reserve deposit ratio; ex. = $7000000/20%=35 in checkable deposits

money supply

=checkable deposits

suppose the price level is equal to 5 (P=5). Now suppose the Federal Reserve Bank conducts open market operations and auctions off govt bonds. Assume nothing else in the economy changes. Because of the sale of bonds, the price level will ____.

Decrease; When the Federal Reserve Bank auctions off govt bonds, ceteris paribus, currency is taken out of circulation and the money supply is decreased. A Decrease in the money supply is graphically demonstrated by shifting the money supply curve to the left. A decrease in the money supply causes the price level to decrease

federal reserve notes are printed by the Federal Reserve Bank

False; All federal reserve notes are printed at the bureau of engraving and printing at the department of treasury, but they are issued by the regional federal reserve banks. The Federal Reserve System is made up of the federal reserve board in Washington, D.C. and 12 regional Federal Reserve Banks located in major cities around the country

the money supply increases when the federal reserve board increases the federal reserve discount rate

False; One of the three Federal Reserve Bank's three monetary policy tools is changing the federal reserve discount rate. The federal reserve discount rate is the interest rate on loans that the federal reserve charges to other banks. When the federal reserve increases the discount rate, ceteris paribus, it discourages banks from borrowing reserves from the Federal Reserve. Thus, an increase in the discount rate reduces the quantity of reserves in the banking system,which in turn reduces the money supply. On the other hand, a decrease in the discount rate, ceteris paribus, encourages borrowing reserves from the federal reserve, which in turn increases the money supply

commodity money has no intrinsic value

False; commodity money is an intrinsically valuable good that also serves as money. Gold is an example of commodity money because it has value even if it were not used as money. Fiat money is paper money that derives its status as money from the power of the state, or by fiat. It is money because the government says that it is money, it otherwise has no real value

currency is defined as paper bills, traveler's checks and coins in the hand of the public

False; currency is one of several types of money. currency is defined as the paper bills and coins in the hands of the public. Other types of money include traveler's checks, demand deposits, other checkable deposits, savings deposits, small time deposits, and money market funds

The M1 definition of the money supply includes currency, traveler's checks and savings deposits, demand deposits, and other checkable deposits

Fasle; when people talk of the quantity of money or the money supply, they are usually thinking about currency - bills and coins. Yet, currency is not the only asset that you can use to purchase goods and services. The federal reserve system, the central bank of the United States, classifies several alternative definitions of money. M1 is narrow, M2 is more expansive

suppose the price level is equal to 5 (P=5). Now suppose the Federal Reserve Bank conducts open market operations and auctions off govt bonds. Assume nothing else in the economy changes. Because of the sale of bonds, the value of unit of money will ____.

Increase; When the Federal Reserve Bank auctions off govt bonds, ceteris paribus, currency is taken out of circulation and the money supply is decreased. A Decrease in the money supply is graphically demonstrated by shifting the money supply curve to the left. A Decrease in the money supply causes the price level to decrease and the value of each unit of money to increase,

Convenient and widely recognized measure for accounting and transactions; it is a yardstick for measuring the value of all goods and services

Money

Suppose the P=8. The federal reserve bank decreases the required reserve deposit ratio. Assume nothing else changes in the economy. In the money market, this monetary policy change will cause the money ____ curve to shift_____.

Supply; Right; When the Federal Reserve Bank decreases the required reserve deposit ratio, currency is taken out of bank reserves and placed into circulation. As a result the money supply is increased. An increase of money supply is graphically demonstrated by shifting the money SUPPLY curve to the RIGHT

The Federal Open Market Committee decides on changes to the fiscal policy

The Banking Acts of 1933 and 1935 centraluzed power of the Federal Reserve Bank in Washington, D.C. and established the Federal Open Market Committee (FOMC).

M1 Money Supply

The Federal Reserve Bank's most narrow definition of money supply is M1 which includes currency, traveler's checks, demand deposits, and other checkable deposits.

The basic functions of money are: a medium of exchange, a store of value, and a unit of account

True; Money is a medium of exchange because money makes exchange easier. Money is also a store of value because people will hold money only if they believe it will continue to have some value, so money can operate as a unit of exchange only if it serves as a store of value. Money is a unit of account because it is convenient and widely recognized measure for accounting and transactions; it is a yardstick for measuring the value of all goods and services

money

a medium of exchange because it makes exchange easier. It can operate as an exchange only if it serves as a store of value. Lastly, it is a unit of account - convenient and widely recognized measure for accounting and transactions

barter economy

an economy with no money; exchange of goods - must have a double coincidence of wants for exchange to take place;

money market fund

an open end mutual fund which invests only in money markets

M1

classification of money supply that includes currency, traveler's checks, demand deposits, and other checkable deposits

M2

classification of money supply that includes everything in M! plus savings deposits, small time deposits, money market mutual funds, and a few other minor categories

bank reserves

currency held by banks

suppose the price level is equal to 5 (P=5). Now suppose the Federal Reserve Bank conducts open market operations and purchases govt bonds. Assume nothing else in the economy changes. Because of the sale of bonds, the value of one unit of money will____.

decrease

Small time deposit

defined as a deposit that earns a fixed rate of interest if held for a specified period of time; can range from several months to several years. Commonly referred to as certificates of deposit or CDs

currency

defined as the paper bills and coins in the hands of the public

money creation process

describes the amount of money the banking system creates with each dollar held in reserve, i.e. dolars that have not been loaned out by a bank; the banking system's ability to create money depends on the amount of currency held in bank reserves and the required reserve deposit ratio, which is the ratio of bank reserves divided by checkable deposits

assets

equal to the currency sitting in the bank vaults

The Federal Open Market Committee (FOMC)

established by the Federal Reserve Bankc; meets about every six weeks in Washington, D.C. in order to discuss the condition of the economy and consider changes to monetary policy, most important of which is open market operations.

commodity money

exists when some intrinsically valuable good also serves as money. Gold is an example of commodity money because it has value even if it were not used as money

A money market fund is an open-end mutual fund which invests only in stocks and bonds

false; A money market fund is an open-end mutual fund which invests only in money markets. Money market funds invest in short term, one day to one year obligations such as treasury bills, certificates of deposit, and commercial paper

An increase in the required reserve deposit ratio causes the money supply to increase

false; An increase in the required reserve deposit ratio will lead to a decrease in the money supply. On the other hand, a decrease in the required reserve deposit ratio will lead to an increase in the money supply

small time deposits are deposits against which checks may be written

false; a small time deposit is a type of money, which is defined as a deposit that earns a fixed rate of interest if held for a specific period of time. The time period can range from several months to several years. Small time deposits are commonly refurred to as certificates of deposits or CDs

an increase in the value of money from one period to the next is called inflation

false; an increase in the value of money from one period to the next is called deflation. An increase in the value of money can occur because of a decrease in the supply of money, ceteris paribus. On the other hand, a decrease in the value of money from one period to the next is called inflation

fiat money is paper money with intrinsic value

false; paper money has no intrinsic value

There are 10 regional Federal Reserve banks throughout the country

false; the Federal Reserve System is made up of the Federal Reserve Board in Washington, D.C. and 12 regional Federal Reserve Banks located in major cities around the country. The Federal Reserve districts are: Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, ST. Louis, Minneapolis, Kansas City, Dallas and San Francisco.

fiat money (paper money)

has no intrinsic value; paper money that derives its status as money from the power of the state. It is money because the government says that it is money, it otherwise has no real value.

suppose the price level is equal to 5 (P=5). Now suppose the Federal Reserve Bank conducts open market operations and purchases govt bonds. Assume nothing else in the economy changes. Because of the sale of bonds, the price level will ____.

increase;

fiat money

paper money that derives its status as money from the power of the state, or by fiat. It is money because the government says that it is money, it otherwise has n real value

equilibrium exists where the price level is 9 and the money supply equals 25 billion. What is a new possible equilibrium when the federal reserve bank sells some government bonds

price level = 4, money supply = 21 billion; When the federal reserve bank sells government bonds, ceteris paribus, it decreases the supply of money circulating in the economy. In this example, the money supply would shift left from MS2 to MS1. A New possible equilibrium exists at a price level equal to 4 and a money supply equal to 21

Open market operations

purchases and sales of government securities by the Federal Reserve Bank in an effort to influence the money supply. When the Federal Reserve decides to purchase government securities (e.g. treasury bills), ceteris paribus, it is choosing to increase the money supply; and when i decides to sell government securities, ceteris paribus, it is choosing to reduce the money supply

open market operations

purchases and sales of government securities by the federal reserve in an effort to influence the money supply

liabilities

the deposits of the banks customers

discount rate

the interest rate on loans that the federal reserve charges to other banks; increasing this discourages banks from borrowing; increasing reduces the quantity of reserves i n the banking system increases the money supply

when the price level is lower than the equilibrium price level

the market will adjust back to equilibrium in the long run

monetary policy

the setting of the money supply by policymakers at the central bank. The central bank (federal reserve bank in the US) has three tools at its disposal to alter money supply; open market operations, reserve requirement changes, and changes to the Federal Reserve's discount rate

federal reserve notes are printed by a division of the treasury department

true; all federal reserve notes are printed at the Bureau of Engraving and Printing at the Department of Treasury, but they are issued by the regional Federal Reserve banks. The Federal Reserve System is made up of the Federal Reserve Board in Washington, D.C. and 12 regional Federal Reserve Banks located in major cities around the country.

the money supply decreases when the federal reserve bank increases the federal discount rate

true; one of the federal reserve bank's three monetary policy tools is changing the Federal Reserve discount rate. The federal reserve discount rate is the interest rate on loans that the federal reserve charges to other banks. When the federal reserve increases the discount rate, ceteris paribus, it discourages banks from borrowing reserves from the Federal Reserve. Thus, an increase in the discount rate reduces the quantity of reserves in the banking system, which in turn reduces the money supply. On the other hand, a decrease in the discount rate, ceteris paribus, encourages borrowing reserves from the Federal Reserve, which in turn increases the money supply.

open market operations are purchased and sales of government securities by the federal reserve bank in an effort to change the money supply

true; one of the federal reserve bank's three monetary policy tools is to conduct open market operations. Open market operations are purchases and sales of government securities by the federal reserve in an effort to influence the money supply. When the Federal Reserve decides to purchase government securities, it is choosing to increase the money supply; and when it decides to sell government securities, it is choosing to reduce the money supply

the Federal Reserve Bank has three monetary policy tools: open market operations, reserve requirement changes, and changes to the Federal Reserve's discount rate

true; the control of the money supply by the Federal Reserve Bank is known as monetary policy. The Federal Reserve has three tools at its disposal to alter the money supply: open market operations, reserve requirement changes, and changes to the Federal Reserve's discount rate

if the price level increases, the value of money decreases

true; the price level and the value of money are directly related. As the overall level of prices increases, the value of a unit of money decreases. For example, if we observe the rice of a bottle of soda increasing fro 5 cents to $1.25 over 80 years, it s likely that the satisfaction level has stayed the same an the money used to purchase the soda as decreased n value because of an increase in the price level.

increase/decrease ,money supply

when the federal reserve decides to purchase government securities, increase in money supply; when the federal reserve sells govt securities it reduces the money supply