ECON 2301: CH. 30 Study Guide

In the United States, how much of an individual's money deposited at a bank is completely insured by the FDIC if that bank fails?

$250,000 The United States offers 100% insurance up to $250,000. If two different banks fail, someone with $200,000 deposited at each bank can expect to receive $400,000 from the FDIC.

If a country's required reserve ratio is 8%, when the central bank puts $1,000 of new currency into circulation, by how much can the money supply grow assuming all currency is deposited in a bank and no banks hold excess reserves? Use the simple money multiplier.

$12,500 Money multiplier: mᵐ=『1╱0.08』=12.5

Identify each action by the Fed as expanding the money supply, shrinking it, or neither. I. The Fed lends money to struggling banks. II. The Fed buys mortgage-backed securities. III. The Fed regulates banks to ensure stability. IV. The Fed sells Treasury bonds to investors.

I. expands the money supply II. expands the money supply III. neither expands nor shrinks IV. shrinks the money supply

Match the type of bank to its correct description. I. the type of bank that typically serves to help firms raise money to invest II. the type of bank citizens use to open a checking account or take out an auto loan III. the Federal Reserve

I. investment bank Investment banks assist in raising financial capital. II. commercial bank Commercial banks are private firms that accept deposits and extend loans (e.g. , Wells Fargo National Bank). III. central bank The Fed is a bank for banks.

Match each term to the corresponding definition. I. the amount of deposits a bank must hold in reserve and cannot lend II. the purchase or sale of bonds by the central bank III. rate of interest paid by private banks to the Fed IV. money lent by the Fed to private banks

I. reserve requirement The required reserve ratio is determined by the central bank. II. open market operations When the Fed purchases bonds, it creates new money. When it sells bonds, it takes money out of the economy. III. discount rate The rate is paid on money lent out by the Fed. IV. discount loans Discount loans do not normally play a large role in the overall monetary policy operation. Reserve requirements and discount loans are no longer actively used to implement monetary policy, but both are historically important.

Discount loans extended by the Federal Reserve Bank _____ normally an important factor in the macroeconomy. However, in crises discount loans are a safety net that reassures the _____. It is in the economy's best interest that the Fed serves as a regulator of banks because of the _____ nature of banking.

are not, financial market, interdependent In 2008, the Fed made discount loans to other financial institutions besides just struggling banks. This was an unprecedented move, to prevent a domino-like collapse of the U.S. financial system.

Anna has a yard full of chickens but needs milk for her baby. Josiah, who is allergic to eggs, has a cow that produces milk. Put the events in order to describe how Anna obtains milk by the barter method.

1. Anna takes eggs from her chickens to Josiah to trade for milk. Initially, Anna hopes for a simple eggs-for-milk transaction. 2. Josiah tells Anna he does not eat eggs, but will accept apples in exchange for milk. There will be no trade without a double coincidence of wants. 3. Anna finds someone who has apples and is willing to trade them for eggs. In order for Anna to get the milk she wants, she must make an additional trade to obtain apples, which Josiah will accept as payment for milk. 4. Anna gives apples to Josiah and gets milk in return. The presence of someone who had something Josiah wanted and wanted something Anna had was key to making the combination of trades work. Barter economies often require an individual to engage in multiple transactions to satisfy a simple need or want.

Suppose the M2 money supply is $13 trillion, including: ● $1 trillion in currency ● $3 trillion in checking accounts ● $7 trillion in savings accounts ● $1 trillion in money market mutual funds ● $1 trillion in certificates of deposit What is the M1 money supply?

4 trillion dollars M1 is currency plus checkable deposits. To find M1 from M2, subtract everything that is not currency or checkable deposits.

A bank has $320 million in deposits, of which it is holding $39 million in reserves. If the required reserve ratio is 10%, what is the maximum amount the bank could still lend out, as new loans?

7 million dollars Based on the required reserve ratio of 10%, the bank is required to hold only $32 million in reserves (10% of $320 million). $39 million minus the minimum of $32 million equals $7 million. To calculate the excess reserves, subtract the minimum reserves required from the total reserves. The amount of excess reserves is equal to the maximum new loan amount the bank can extend.

If the Federal Reserve Bank wanted to set the money multiplier at mm = 12.5, what reserve ratio should it require? (Use the simple money multiplier for this calculation.)

8% The reserve ratio is rr = 『1╱mᵐ』=『1╱12.5』=0.08=8\%

Consider this hypothetical balance sheet for YooHoo Bank, in the fictional country of Hellond. YooHoo Bank Assets(in thousands of U.S. dollars) Government securities $1,700 Required reserves $800 Excess reserves $100 Loans $8,900 Total assets $11,500 Liabilities and owner's equity(in thousands of U.S. dollars) Checking deposits $10,000 Owner's equity $1,500 Liabilities and net worth $11,500 Calculate YooHoo Bank's required reserve ratio, as a percentage. Round to the nearest percent if necessary.

8% 『required reserves╱total deposits』=『800╱10,000』=0.08=8 Hellond's reserve requirement is different from the 10% requirement in the United States. required reserves = rr x deposits

Click on the two quantities that must be equal for the financial statement to be balanced.

Click on "Total assets" and "Total liabilities and net worth" The left side of a bank's balance sheet shows how the bank chooses to use its funds. The right side of a bank's balance sheet shows the sources of the firm's funds. The two quantities that must be balanced typically appear in a highly visible location on a financial statement, for easy reference.

What factors prompted banks to suddenly start holding excess reserves in 2008, as shown in the graph?

Contributed to Excess Reserves: - During the Great Recession, lending money became riskier. A main trigger of the Great Recession was defaults on home loans. - The Fed began paying interest on reserves banks deposited with it. The Fed wanted to encourage banks to hold reserves instead of making high-risk loans. Did Not Contribute to Excess Reserves: - Banks' profits exceeded their ability to find lenders. The Great Recession was not an especially profitable time for banks. - The Fed set the reserve requirement lower than banks wanted. The reserve requirement had not changed.

Which of the following are functions of money?

Correct Answer(s): - It can be traded for goods and services. This is what is meant by saying that money is a medium of exchange. - It provides a standard measure for prices to be quoted in. This is what is meant by saying that money is a unit of account. - It has value, so owning money allows people to hold wealth. This is what is meant by saying that money is a store of value. Incorrect Answer(s): - It provides individuals the opportunity to engage in barter. Barter is a direct exchange of one good for another. It does not require money. - It requires a double coincidence of wants. That is characteristic of barter transactions. Money eliminates this requirement.

Which of the following actions qualify as open market operations?

Correct Answer(s): - The Fed sells U.S. Treasury bonds to a private bank. This action represents money being taken out of the economy. - The Fed buys U.S. Treasury bonds from a financial institution. This action represents an injection of money into the economy. Incorrect Answer(s): - The Fed sets the interest rate it pays on deposits from private banks. The rate may indirectly affect the open market, but this is not an open market operation. - The Fed takes in deposits from private banks. This is a federal funds transaction, not an open market operation. In open market operations, the Fed buys and sells Treasury securities in an effort to control the money supply.

Which of the following is true if you deposit $1,000 in a bank checking or savings account? Assume a 10% bank reserve requirement.

Correct Answer(s): - The bank's reserves will increase by at least $100. Unless someone else makes a withdrawal at the same time you are depositing your money, the bank's reserves must increase by at least 10% of your deposit. - The bank has $900 it can lend to someone else. Based on the 10% reserve requirement, the bank can lend out up to 90% of the money deposited. Loaning out the full amount is in the bank's best interest because interest paid on loans is how banks are profitable. - You have $1,000 available to spend if you choose. Money in a typical checking or savings account can be accessed using checks or a debit card; that is what the accounts are for. Incorrect Answer(s): - The bank's liabilities decrease by at least $1,000. Deposits are money lent to the bank and therefore are counted as liabilities (money the bank owes the depositors). Your deposit increases the bank's liabilities by $1,000. - The bank has $1,000 it can lend to someone else. The bank is required to keep some money in reserve. That is the purpose of the 10% required reserve ratio. The amount the bank is required to keep on reserve is in constant flux because the total amount of its deposits is in constant flux. When a bank loans out your funds to another person, while also keeping them available for you to withdrawal, it is essentially creating money.

Which items are parts of the M1 money supply?

Correct Answer(s): - currency In modern monetary systems, currency is the most elemental form of money. - money in checking accounts Money in checking accounts, called "checkable deposits," is considered effectively as good as cash. - traveler's checks Traveler's checks are effectively as good as cash. These are a very minor part of the overall calculation. Incorrect Answer(s): - certificates of deposit (CDs) Money in CDs is part of the M2 money supply but not the M1 money supply. It is less liquid than cash or checkable deposits, since early withdrawal of money in CDs carries a financial penalty. - money in savings accounts Money in savings accounts is part of the M2 money supply but not the M1 money supply. Savings are considered slightly less liquid, meaning they are not quite so easy to spend. However, since today one can move money between savings and checking using a smart phone, the M1/M2 distinction is less important than it once was.

The Federal _____ Corporation makes sure _____ get their money back if an insured bank fails. This agency was implemented during the _____ in response to the high number of bank failures. The peace of mind the FDIC provided depositors resulted in a decreased frequency of _____. However, since banks and their customers are no longer fully exposed to risk, there is increased potential for _____.

Deposit Insurance, depositors, Great Depression, banks run, moral hazard Banks often include the phrase "Member, FDIC" in their advertising as reassurance for prospective customers.

Which scenarios are examples of a double coincidence of wants?

Double Coincidence of Wants: - Chad has a desk that Aiden wants, and Aiden has money that Chad wants. Money is a tradable commodity that makes double coincidences of wants routine. - Devon has a pumpkin that Ella wants, and Ella has a hat that Devon wants. Each party has something the other wants. Not a Double Coincidence of Wants: - Alma has a car that Bruno wants and also has a rug that Bruno wants. Unless Bruno has something Alma wants, there is no potential for barter. - Boris has a pair of concert tickets that Elaine wants, and Elaine has a barely used laptop that Fiona wants. Elaine would need to have something Boris wants, or Fiona would need to have something Elaine wants. - Claire has a sandwich that Ed wants, and Bill has a dessert that Diane wants. There is no pairing of two people each wanting what the other has. In a single coincidence of wants, a person who wants something meets a person who has it (and might be willing to part with it). A double coincidence occurs when two people meet who each want something the other person has; then a trade is possible.

For two people to successfully barter, there needs to be a double coincidence of wants. What does this mean?

Each party's desires match up with something the other party has. Without money in an economy as a medium of exchange everyone can use, transactions could take place only when double coincidences of wants occur. This makes bartering an inefficient alternative to money.

Credit cards are included in the money supply.

False Purchases made with credit cards involve a loan extended right at the cash register. When the loan is made, the credit card company is actually paying for the purchase, until the cardholder later repays the loan.

The ability to regulate commercial banks and monitor bank balance sheets is outside the Fed's authority. It is the duty of commercial banks to privately monitor their own activities.

False The Fed is charged with ensuring the financial stability of banks, which includes monitoring bank activities and making sure a bank limits risk and doesn't lend more than it should.

Around the time of the _____, the Fed stopped actively using the _____ to administer monetary policy. When it did use this tool, an increase would _____ borrowing by banks, and a decrease would _____ bank borrowing. Today, banks are generally discouraged from borrowing from the Fed, unless the banks are _____.

Great Depression, discount rate, discourage, encourage, struggling In 2008, the Fed made discount loans to other financial institutions besides just struggling banks. This was an unprecedented move, to prevent a domino-like collapse of the U.S. financial system.

Most open market operations are routine and are aimed at maintaining the economic status quo. During the _____, however, a new form of open market operations were used to encourage economic growth. These actions, which were _____ targeted, were dubbed "_____." The first round of this practice focused primarily on the _____ market.

Great Recession, narrowly, quantitative easing, housing Quantitative easing is viewed by some critics of the Fed as "printing money" under another name.

Place the events in order to describe how a bank with a temporary reserve shortfall uses a short-term loan to bring its reserves up to the required level.

I. Lending activity depletes American Bank's reserves below the required reserve level. II. American Bank takes out a short-term loan with TrueBlue Bank. The Fed facilitates the transaction. III. The loan to American Bank begins earning interest for TrueBlue Bank at the federal funds rate. IV. With some of its own borrowers paying off loans and new deposits coming in, American Bank no longer needs the money borrowed from TrueBlue Bank. V. American Bank pays off the loan and is able to maintain in the required reserves.

Place the events in order to describe how money the Fed adds to the economy starts to be multiplied. The reserve requirement in this example is 10%.

I. The Fed buys a security from a bank for $1,000. II. The bank sets $100 aside as a required reserves. III. The bank lends $900 to a customer needing a loan. IV. The customer spends the $900 at a store. V. The store owner deposits the $900 in another bank. The process continues when the new bank sets $90 of the $900 aside as reserves and lends the rest out. As the table shows, eventually up to $10,000 can be created this way.

Match each type of money to the corresponding definition. I. paper bills and coins used as money II. money that can be exchanged for a commodity at a fixed rate. III. money that has no value except as a medium of exchange IV. an exchangeable good of intrinsic value, such as silver or tobacco

I. currency Currency is produced at government printing plants and mints. II. commodity-backed money The United States used commodity-backed money until 1971. III. fiat money Fiat money has value by virtue of the law stating that it can be used to pay debts. IV. commodity money Commodity money can be cumbersome to transport.

Match each term to the corresponding definition. I. money lent by the Fed to private banks II. money deposited with the Fed by private banks III. rate of interest paid by private banks to the Fed IV. rate of interest paid on interbank loans

I. discount loans Discount loans do not normally play a large role in the overall monetary picture. II. federal funds Federal funds are not actually owned by the Fed. They belong to private banks and are on deposit at the Fed. III. discount rate The rate is paid on money lent out by the Fed. IV. federal funds rate This is the interest rate charged when private banks loan reserves to other banks.

Identify each attribute as being associated with fiat money, commodity-backed money, or both. I. A government can expand the supply deliberately and quickly. II. not tied to a good for which the demand can change III. U.S. silver certificates are a historical example. IV. a type of money used in the United States prior to 1971 V. not tied to anything with intrinsic, stable value VI. more portable than commodity money VII. type of money used in most modern economies

I. fiat money When a government begins "printing money" indiscriminately, the result is hyperinflation. II. fiat money Gold-backed currency will rapidly devalue if there is a sudden glut of gold on the market. This cannot happen to fiat money. III. commodity-backed money Along the bottom, a silver certificate reads, "One dollar in silver payable to the bearer on demand." IV. commodity-backed money With commodity-backed money, the value of the currency fluctuates only to the extent that the value of the associated commodity does. V. fiat money Fiat money will rapidly devalue if the government decides to print a lot more of it. VI. both Paper currency is more easily transported than a standard trading good such as gold, tobacco, or furs. VII. fiat money The United States and other industrialized nations have used fiat money since the 1970s. For better or worse, fiat money gives the government greater year-to-year control over the money supply than commodity-backed money does.

Match each term to the corresponding description. I. financial obligations the bank owes to others II. the portion of bank deposits that is set aside and not lent out III. a bank's assets minus the bank's liabilities IV. items a bank owns

I. liabilities Liabilities include deposits made by households to banks. II. reserves Banks usually try to keep reserves near the legal minimum. They typically want to devote as much of their funds to work in the form of loans as they can. III. owner's equity Owner's equity is just the difference between assets and liabilities on a balance sheet. IV. assets A bank may, for instance, own Treasury securities.

Apply the correct labels to the diagram of fractional reserve banking. Not all labels will be used.

Left blue box: money deposited Middle top green box: available for loans Middle bottom green box: reserves Right blue box: money lent

After a sluggish quarter, the Federal Reserve Bank decides to increase the money supply in the economy. When the money-creation process is complete, the Fed wants there to be $20 billion worth of new funds in the money supply. If the required reserve ratio is 5%, what is the simple money multiplier, and by how much should the Fed initially increase the money supply? Assume that all currency is deposited in banks and that banks hold no excess reserves.

Money multiplier: 20 Here, mᵐ=『1╱0.05』=20. Initial money increase: $1 billion This initial money supply, multiplied by the money multiplier, equals the total amount of new funds: $20 billion. The money multiplier is not simply equal to the required reserve percentage. Use the formula: mᵐ=『1╱rr』

Drag each component of the M2 money supply into place in the figure. M2: Orange Top box (blank) 2nd Orange top box (blank) M1{ 2nd to last Blue box (blank) M1{ Last Green box (Currency)

Orange top box: savings deposits In addition to cash-like money, M2 contains money in savings. 2nd orange top box: small time deposits In addition to cash-like money, M2 contains money in savings, such as certificates of deposit. 2nd to last blue box: checking deposits Money in a checking account plays much the same role as cash. It is important to remember that purchases made with credit cards are not part of the money supply, which is why they are not included in this figure.

Place each quantitative easing amount in the appropriate spot in the timeline.

QE 1 begins: 1.725 trillion dollars The first QE initiative was the largest. QE 2 begins: 600 billion dollars After the economy stalled in 2010, the Fed undertook a second round of quantitative easing. QE 3 begins: up to 85 billion dollars per month This last round was ongoing as of Fall 2014.

Which of the following are responsibilities of the Federal Reserve?

Responsibilities of the Federal Reserve: - Apply a countercyclical economic policy to the money supply. Specifically, Congress has charged the Federal Reserve bank with keeping unemployment down and keeping prices stable. - Set the required reserve ratio for banks. This is part of the Federal Reserve's bank-regulation activity. - Act as a bank for banks, both accepting deposits and extending loans. This is what is meant by calling the Federal Reserve the nation's central bank. Not a Responsibility of the Federal Reserve: - Raise money for the operations of the federal government by selling bonds. That is done by the Treasury department. The Federal Reserve may buy some of those bonds, but that is a separate decision. The Federal Reserve is an independent central bank, not part of the federal government, that has a mandate from Congress to manage the banking system and the money supply so that prices remain stable and unemployment stays as low as possible.

In the wake of the Great Recession, how did the amount of reserves held by banks change?

The Fed began paying interest on reserves, so the amount of excess reserves held by banks increased significantly.

Suppose that inflation has started to creep upward, and the Fed wants to use open market operations to counteract this trend. Drag the correct labels and statement into place to describe the Fed's actions.

Top box: government securities Middle box: result: less money in the economy Bottom box: dollars In open market operations, the Fed purchases or sells bonds. In this way, the market for loanable funds either grows or shrinks, which affects the money supply. To counteract inflation, the Fed will want to take moves to reduce the money supply.

The simple money multiplier, mᵐ=『1╱rr』, is greater than the real-world money multiplier.

True

In recent decades, as the Fed administers monetary policy, it has relied less on adjustments to the reserve requirement and the discount rate than it used to.

True The Fed has developed other, better policy tools for controlling the money supply and now makes much less use of the reserve requirement or discount rate for that purpose.

Money's role as a store of value is less important today than it once was.

True Today most of our stored value is "virtual": it exists in the form of account balances rather than bills and coins.

What accounts for the difference between the two curves shown in the figure?

banks' need to cover expenses and make a profit Banks charge more on loans than they pay out to the depositors whose money they are lending out.

Arrange the systems of economic exchange according to the order in which they historically appeared, from ancient times to the present.

barter system, commodity money, commondity-backed money, fiat money A barter system does not use money in any form. This is very inefficient, which is why societies develop a medium of exchange. An example of commodity money would be half-pound bags of salt used as a common medium of exchange. The U.S. dollar was commodity-backed in the days when the country was still on the gold standard. Today, the U.S. dollar is an example of fiat money.

The main function of _____ banks is to accept deposits and then to lend the same money (minus _____) back out. Banks make a profit by charging a higher interest rate on _____ than the interest rate they pay on _____. Through the loan process, banks are actually able to _____ money.

commercial, required reserves, loans, deposits, create By acting as intermediaries, banks enable depositors to earn interest and at the same time enable borrowers to engage in ventures that would be impossible without the loaned money.

When a bank customer makes a _____, the bank takes possession but the customer still has the money available for use. However, when the bank then _____ the money, the _____ has use of the money, too. In this way, two people are using the same money at the same time. The money has in effect been multiplied.

deposit, lends out, borrower Money that is not lent out goes into reserves and does not contribute to money creation.

What is the one tool the Federal Reserve Bank uses every day?

open market operations The typical open market operation is the purchase or sale of U.S. Treasury bonds. This is the single tool the Fed uses every day to control the money supply.

Place the components of the M2 money supply in order, from smallest to largest.

small time deposits, money market mutual funds, currency, checkable deposits, savings deposits In 2018, small time deposits accounted for $538 billion. Like small time deposits, money market mutual funds account for a relatively small portion of M2. This is the first, slightly smaller, component of M1. This is the second, slightly larger, component of M1. These make up over half of M2. Since the 1970s and the arrival of ATMs, ease of withdrawal from savings accounts has made the distinction between checking and savings less important. Now, M2 is a much better measure of the money supply than M1.

What is the primary objective of open market operations by the Federal Reserve Bank?

to grow or shrink the money supply By adjusting the nation's money supply, the Fed tries to manage inflation and keep the economy on a steady course.

In barter economies, goods and services are _____ without the use of money. Therefore, in order for a trade to occur, a _____ is required. With the introduction of _____, trade becomes much easier: there is now a _____ between buyers and sellers.

traded, double coincidence of wants, money, medium of exchange Money is able to play the role of a medium of exchange because everyone in the economy wants it.

Because money creates a standard _____, it is possible to compare the prices of two goods, which allows people to communicate the _____ of the goods in a way that is easily understood. This characteristic of money also enables it to serve as a _____ device, or a way to measure accounts and transactions in a consistent manner.

unit of account, value, recording Besides being a unit of account, money is also a medium of exchange and a store of value.