ECON 2411 - Ch. 14 The Money Supply Success

The First National Bank receives an extra $100 of reserves but decides not to lend any of these reserves. How much deposit creation takes place for the entire banking system?

$0.

As financial intermediaries, banks:

accept deposits and make loans

The monetary base is comprised of:

currency in circulation and reserves.

Two primary assets of the Federal Reserve System are:*

government securities and loans to commercial banks.*

Under 100% reserve banking, the money multiplier will be:*

1*

Classify the following transaction as affecting either assets, a liabilities, or neither for each of the "players" in the money supply process - the Federal Reserve, banks, and depositors. The Fed provides an emergency loan to a bank for $1,000,000. A bank borrows $500,000 in overnight loans from another bank. You use your debit card to purchase a meal at a restaurant for $100.

Banks: Assets and liabilities increase. Fed: Assets and liabilities increase. Assets and liabilities of the banking system as a whole are unaffected, however, individual bank balance sheets will change. Depositors: Assets rise and are offset by a fall in assets due to lower checking account balances. Banks: Reserve assets decrease and checkable deposit liabilities decrease.

Suppose that the Fed buys $1 million of bonds from the First National Bank. If the First National Bank and all other banks use the resulting increase in reserves to purchase securities only and not to make loans, what will happen to checkable deposits? Assume the required reserve ratio is 10 percent.

Change of D = 1 / rr x Change of R Checkable deposits increase by $10 million.

If a bank decides that it wants to hold $1 million of excess reserves, what effect will this have on checkable deposits in the banking system? Assume that the required reserve ratio on checkable deposits is 10% and the public's holdings of currency do not change.*

Checkable deposits decline by $10 million.*

Assume that the required reserve ratio on checkable deposits is 10%, banks do no hold any excess reserves, and the public's holdings of currency do not change. If the Fed reduces reserves by selling $5 million worth of bonds to the banks, what will the T-account of the banking system look like when the banking system is in equilibrium? What will have happened to the level of checkable deposits?

Checkable deposits fall by $50 million and the T-account is:

What happens to checkable deposits in the banking system when the Fed lends an additional $1 million to the First National Bank, assuming that the required reserve ratio on checkable deposits is 10%, banks do not hold any excess reserves, and the public's holdings of currency do not change?

Checkable deposits rise by $10 million.

"The Fed can perfectly control the amount of reserves in the system." Is this statement true, false, or uncertain? Explain your answer.

False. A shift from deposits to currency will affect the amount of reserves, and since other players are involved in this process, the Fed ultimately cannot control the level of reserves in the system.

"The Fed can perfectly control the amount of the monetary base, but has less control over the composition of the monetary base." Is this statement true, false, or uncertain? Explain your answer.

False. Since the Fed cannot control the amount of discount lending to financial institutions, it does not have perfect control over the amount of reserves in the banking system and hence the monetary base.

If the Fed sells $2 million of bonds to the First National Bank, what happens to reserves and the monetary base? Complete the T-accounts below to explain your answer. First National Bank > Assets > Reserves ____ ; Securities ____ Federal Reserve System > Assets > Securities ___ ; Liabilities > Reserves _____ Reserves _____, and the monetary base _____.

First National Bank > -$2 million ; +$2 million Federal reserve system > -$2 million ; -$2 million fall by $2 million, falls by $2 million.

If Jane Brown closes her account at the First National Bank and uses the money instead to open a money market mutual fund account, what happens to M1? Why?*

M1 does not change because the funds that go to the money market mutual fund are first deposited into the mutual fund's bank account. *

If a bank depositor withdraws $1,00 of currency from an account, what happens to reserves, checkable deposits, and the monetary base? Assume that the required reserve ratio on checkable deposits is 10% and banks do not hold any excess reserves.

Reserves fall by $1,000, checkable deposits fall by $10,000, and the monetary base remains uncharged.

Why might the procyclical behavior of interest rates (rising during the business cycle expansions and falling during recessions) lead to procyclical movements in the money supply?

The excess reserves ratio e falls with rising interest rates and the money supply rises when e falls and discount loans borrowing is positively related to the level of discount loans from the Fed.

If the economy starts to boom and loan demand picks up, what do you predict will happen to the money supply?*

The money supply will increase.*

The money multiplier declined significantly during the period 1930-1933 and also during the recent financial crisis of 2008-2010. Yet the M1 money supply decreased by 25% in the Depression period but increased by more than 20% during the recent financial crisis. What explains the difference in outcomes?

There was a significant increase in the monetary base during the recent financial crisis.

As financial intermediaries, banks:*

accept deposits and make loans*

Reserves are:

assets for banks, deposits at the Fed plus vault cash, and liabilities for the Fed.

Loans that the Fed makes to banks appear on the balance sheet as part of its _____, and deposits made by banks appear on the Fed's balance sheet as part of its ____.

assets; liabilities.

By definition, when the Fed conducts an open market purchase, it is:

buying bonds and increasing the quantity of reserves.

The Federal Reserve System is the ___ for the United States, which is defined as the government agency responsible for ____.

central bank; the conduct of monetary policy

What effect might a financial panic have on the money multiplier and the money supply? Why? In a financial panic, you would expect the money multiplier to ___ and the money supply to ____, which would cause the excess reserves ratio to ___. Thus depositors are likely to ____ their holdings of currency.

decrease; decrease; increase; increase

The money multiplier when people hold currency and when banks hold excess reserves is ____ the simple multiplier (the multiplier founds when currency held and excess reserves are both zero).*

smaller than*

The monetary base is affected by:*

the Federal Reserve through open market operations, the Federal Reserve through its extension of discount loans, and float and Treasury deposits at the Federal Reserve.

The players in the money supply process include all of the following except:

the Treasury.

Predict what will happen to the money supply if there is a sharp rise in the currency ratio.

the money supply falls

The M2 money multiplier increases in value when the:*

time deposit ratio (t) increases and money market fund ratio (mm) increases.*

The interest rate charged to banks that borrow funds from the Fed is known as the:*

discount rate*