Deck 19: A Macroeconomic Theory of the Open Economy

Question 1

In a fractional-reserve banking system, banks create money when they:

A)accept deposits.
B)make loans.
C)hold reserves.
D)exchange currency for deposits.

Answer 1

B

Question 2

Banks create money in:

A)a 100-percent-reserve banking system but not in a fractional-reserve banking system.
B)a fractional-reserve banking system but not in a 100-percent-reserve banking system.
C)both a 100-percent-reserve banking system and a fractional-reserve banking system.
D)neither a 100-percent-reserve banking system nor a fractional-reserve banking system.

Answer 2

B

Question 3

Bank reserves equal:

A)gold kept in bank vaults.
B)gold kept at the central bank.
C)currency plus demand deposits.
D)deposits that banks have received but have not lent out.

Answer 3

D

Question 4

If the proceeds of all loans are deposited somewhere in the banking system and if rr denotes the reserve-deposit ratio, then the total money supply is:

A)reserves divided by rr.
B)1/rr.
C)reserves times rr.
D)reserves divided by (1 - rr).

Question 5

In the United States, the money supply is determined:

A)only by the Fed.
B)only by the behavior of individuals who hold money and of banks in which money is held.
C)jointly by the Fed and by the behavior of individuals who hold money and of banks in which money is held.
D)according to a constant-growth-rate rule.

Question 6

If currency held by the public equals $100 billion, reserves held by banks equal $50 billion, and bank deposits equal
$500 billion, then the monetary base equals:

A)$50 billion.
B)$100 billion.
C)$150 billion.
D)$600 billion.

Question 7

The ratio of the money supply to the monetary base is called the:

A)currency-deposit ratio.
B)reserve-deposit ratio.
C)high-powered money.
D)money multiplier.

Question 8

In a system with fractional-reserve banking:

A)all banks must hold reserves equal to a fraction of their loans.
B)no banks can make loans.
C)the banking system completely controls the size of the money supply.
D)all banks must hold reserves equal to a fraction of their deposits.

Question 9

In the United States, bank reserves consist of:

A)currency and demand deposits.
B)vault cash and deposits at the Federal Reserve.
C)gold deposits at the Federal Reserve.
D)the money supply.

Question 10

The size of monetary base is determined by:

A)the Federal Reserve.
B)the Federal Reserve and banks.
C)preferences of households about the form of money they wish to hold.
D)business policies of banks and the laws regulating banks.

Question 11

The reserve-deposit ratio is determined by:

A)the Federal Reserve.
B)business policies of banks and the laws regulating banks.
C)preferences of households about the form of money they wish to hold.
D)the Federal Deposit Insurance Corporation (FDIC).

Question 12

If currency held by the public equals $100 billion, reserves held by banks equal $50 billion, and bank deposits equal
$500 billion, then the money supply equals:

A)$100 billion.
B)$150 billion.
C)$600 billion.
D)$650 billion.

Question 13

The difference between banks and other financial intermediaries is that only banks have the legal authority to:

A)transfer funds from savers to borrowers.
B) pay interest on debt obligations.
C)manage portfolios of assets.
D)create assets that are part of the money supply.

Question 14

In a 100-percent-reserve banking system, if a customer deposits $100 of currency into a bank, then the money supply:

A)increases by $100.
B)decreases by $100.
C)increases by more than $100.
D)remains the same.

Question 15

The currency-deposit ratio is determined by:

A)the Federal Reserve.
B)business policies of banks and the laws regulating banks.
C)preferences of households about the form of money they wish to hold.
D)the Federal Deposit Insurance Corporation (FDIC).

Question 16

In a fractional-reserve banking system, banks create money because:

A)each dollar of reserves generates many dollars of demand deposits.
B)banks have the legal authority to issue new currency.
C)funds are transferred from households wishing to save to firms wishing to borrow.
D)the wealth of the economy expands when borrowers undertake new debt obligations.

Question 17

Liabilities of banks include:

A)reserves.
B)currency in the hands of the public.
C) loans to customers.
D)demand deposits.

Question 18

The preferences of households determine the:

A)reserve-deposit ratio.
B)currency-deposit ratio.
C)size of the monetary base.
D)loan-deposit ratio.

Question 19

The monetary base consists of:

A)currency held by the public, plus reserves held by banks.
B)all outstanding currency, plus reserves held by banks.
C)all outstanding currency, plus demand deposits.
D)all bank reserves.

Question 20

The banking system creates:

A)liquidity.
B)wealth.
C)reserves.
D)currency.

Question 21

If the ratio of currency to deposits (cr) increases, while the ratio of reserves to deposits (rr) is constant and the monetary base (B) is constant, then:

A)it cannot be determined whether the money supply increases or decreases.
B)the money supply increases.
C)the money supply decreases.
D)the money supply does not change.

Question 22

When the Fed decreases reserve requirements, it:

A)increases the reserve-deposit ratio (rr).
B)decreases the reserve-deposit ratio (rr).
C)increases the monetary base (B).
D)decreases the monetary base (B).

Question 23

When the Federal Reserve conducts an open market purchase, it buys bonds from the:

A)public.
B)U.S. Treasury.
C)Internal Revenue Service.
D)International Monetary Fund.

Question 24

If the Federal Reserve wishes to increase the money supply, it should:

A)decrease the discount rate.
B)increase reserve requirements.
C)sell government bonds.
D)decrease the monetary base.

Question 25

When the Fed decreases reserve requirements, if the ratio of currency to deposits decreases also while the monetary base is constant, then:

A)it cannot be determined whether the money supply increases or decreases.
B)the money supply increases.
C)the money supply decreases.
D)the two changes exactly offset each other.

Question 26

When the Fed increases the discount rate, it:

A)increases the reserve to deposit ratio (rr).
B)decreases the reserve to deposit ratio (rr).
C)is likely to increase the monetary base (B).
D)is likely to decrease the monetary base (B).

Question 27

If the reserve-deposit ratio is less than 1, and the monetary base increases by $1 million, then the money supply will:

A)increase by $1 million.
B)decrease by $1 million.
C)increase by more than $1 million.
D)decrease by more than $1 million.

Question 28

If the currency-deposit ratio equals 0.5 and the reserve-deposit ratio equals 0.1, then the money multiplier equals:

A)0.6.
B)1.67.
C)2.0.
D)2.5.

Question 29

If you hear in the news that the Federal Reserve conducted open market purchases, then you should expect to increase.

A)reserve requirements
B)the discount rate
C)the money supply
D)the reserve-deposit ratio

Question 30

If the ratio of reserves to deposits (rr) increases, while the ratio of currency to deposits (cr) is constant and the monetary base (B) is constant, then:

A)it cannot be determined whether the money supply increases or decreases.
B) the money supply increases.
C)the money supply decreases.
D)the money supply does not change.

Question 31

The money supply will decrease if the:

A)monetary base increases.
B)currency-deposit ratio increases.
C)discount rate decreases.
D)reserve-deposit ratio decreases.

Question 32

To increase the money multiplier, the Fed can:

A)conduct open-market purchases.
B)conduct open-market sales.
C)raise the required reserve ratio.
D)lower the required reserve ratio.

Question 33

High-powered money is another name for:

A)currency.
B)demand deposits.
C)the monetary base.
D)M3.

Question 34

The interest rate charged on loans by the Federal Reserve to banks is called the:

A)federal funds rate.
B)prime rate.
C)discount rate.
D)Treasury bill rate.

Question 35

The money supply will increase if the:

A)currency-deposit ratio increases.
B)reserve-deposit ratio increases.
C)monetary base increases.
D)discount rate increases.

Question 36

Excess reserves are reserves that banks keep:

A)in their vaults.
B)at the central bank.
C)to meet legal reserve requirements.
D)above the legally required amount.

Question 37

When the Fed makes an open-market sale, it:

A)increases the money multiplier (m).
B)increases the currency-deposit ratio
C)(cr). increases the monetary base (B).
D)decreases the monetary base (B).

Question 38

Open-market operations change the ; changes in reserve requirements change the ; and changes in the discount rate change the .

A)monetary base; monetary base; monetary base
B)money multiplier; money multiplier; money multiplier
D)C.monetary base; money multiplier; monetary base
D)money multiplier; monetary base; money multiplier

Question 39

If the monetary base equals $400 billion and the money multiplier equals 2, then the money supply equals:

A)$200 billion.
B)$400 billion.
C)$800 billion.
D)$1,000 billion.

Question 40

The most frequently used tool of monetary policy is:

A)open-market operations. changes
B)in the discount rate.
C)changes in reserve requirements.
D)changes in the money multiplier.

Question 41

If many banks fail, this is likely to:

A)increase the ratio of currency to deposits.
B)decrease the ratio of currency to deposits.
C)have no effect on the ratio of currency to deposits.
D)decrease the amount of currency in circulation, if the Fed takes no action.

Question 42

A bank balance sheet consists of only the following items:
$$\begin{array} { l r } \text { Deposits } & \$ 1,000 \\\text { Reserves } & \$ 100 \\\text { Securities } & \$ 400 \\\text { Debt } & \$ 500 \\\text { Loans } & \$ 2,000\end{array}$$
What is the value of bank capital?

A)-$1,000
B)+$500
C)+$1,000
D)+$1,500

Question 43

The value of banks owners' equity is called bank:

A)deposits.
B)reserves.
C)capital.
D)liquidity.

Question 44

The amount of capital that banks are required to hold depends on the:

A)amount of deposits held at a bank.
B)riskiness of the bank's assets.
C)reserve requirements set by the Fed.
D)level of deposit insurance coverage.

Question 45

If many banks fail, this is likely to:

A)cause surviving banks to lower their ratios of reserves to deposits.
B)cause surviving banks to raise their ratios of reserves to deposits.
C)have no effect on the ratio of reserves to deposits in surviving banks.
D)cause surviving banks to hold less currency.

Question 46

$$\text { Question }$$ In the portfolio theory of money demand, all of the following economic factors play a direct role except:

A)the expected real return on stock.
B)the expected inflation rate.
C)the unemployment rate.
D)wealth.

Question 47

Between August 1929 and March 1933, the money supply fell 28 percent. At that time the monetary base and the currency-deposit and reserve-deposit ratios both .

A)fell; fell
B)fell; rose
C)rose; fell
D)rose; rose

Question 48

A shortage of bank capital in 2008 and 2009 led to:

A)decreased money demand.
B)decreased bank lending.
C)increased interest rates.
D)increased reserve requirements.

Question 49

According to portfolio theories of money demand, increases in wealth the demand for money, and increases in the expected inflation rate the demand for money.

A)increase; increase
B)increase; decrease
C)decrease; increase
D)decrease; decrease

Question 50

Transaction theories of money demand emphasize the role of money as a:

A)medium of exchange.
B)store of value.
C)unit of account.
D)standard for making deferred payments.

Question 51

The use of borrowed funds to supplement existing funds for purposes of investment is called:

A)arbitrage.
B)leverage.
C)convergence.
D)intermediation.

Question 52

The quantity theory of money assumes that the demand for real money balances:

A)depends on both the interest rate and income.
B)depends only on the interest rate.
C)is proportional to income.
D)is proportional to the interest rate.

Question 53

Portfolio theories of money demand emphasize the role of money as a:

A)medium of exchange.
B)store of value.
C)unit of account.
D)standard for making deferred payments.

Question 54

The only tax that those in the underground economy probably cannot evade is the:

A)personal income tax.
B)sales tax.
C)inflation tax.
D)corporate income tax.

Question 55

According to portfolio theories of money demand, increases in the expected return on stock the demand for money, and increases in the expected return on bonds the demand for money.

A)increase; increase
B)increase;
C)decrease decrease; increase
D)decrease; decrease

Question 56

$$\begin{array}{l}\text { Table: Bank Balance Sheet }\\\begin{array} { l r l r } \hline \text { Assets } & & { \text { Liabilities \& Net Worth } } \\\hline \text { Reserves } & \$ 10,000 & \text { Deposits } & \$ 100,000 \\\text { Loans } & 100,000 & \text { Debt } & 20,000 \\\text { Securities } & 40,000 & \text { Equity } & 30,000\end{array}\end{array}$$ Reference: Ref 19-1
 
(Table: Bank Balance Sheet) Based on the table, owners' equity will fall to zero if loan defaults reduce the value of total assets by percent.

A)10
B)20
C)30
D)40

Question 57

The demand for money as a medium of exchange is best explained by theories of money demand, while the demand for money as a store of value is best explained by theories of money demand.

A)rational expectations; quantity
B)quantity; rational expectations
C)portfolio; transaction
D)transaction; portfolio

Question 58

Portfolio theories of the demand for money are based on money's function as a , while transaction theories of the demand for money are based on money's function as a .

A)medium of exchange; store of value
B)medium of exchange; unit of account
C)store of value; medium of exchange
D)store of value; unit of account

Question 59

In 2008 and 2009, the U.S. Treasury put public funds in some banks in an attempt to restore bank lending to more normal levels. This infusion of funds initially increased what item on the banks' balance sheets?

A)capital
B)loans
C)securities
D)deposits

Question 60

The minimum amount of owner's equity in a bank mandated by regulators is called a requirement.

A)reserve
B)margin
C)liquidity
D)capital

Question 61

Traditionally, monetary assets differ from nonmonetary assets because only monetary assets:

A)earn interest.
B)serve as a store of value.
C)serve as a medium of exchange.
D)are held by the public.

Question 62

Some nonmonetary assets are called near money because they:

A)are controlled by the Federal Reserve.
B)earn about the same interest rate as money.
C)have nearly the same liquidity as money.
D)generate the same velocity as money.

Question 63

The Federal Reserve has three tools to control the money supply: open-market operations, the discount rate, and reserve requirements.
a. How should each instrument be changed if the Fed wishes to decrease the money supply?
b. Will the change affect the monetary base and/or the money multiplier?

Question 64

If the Baumol-Tobin model of money demand is correct, then as the interest rate increases:

A)there will be no effect on the velocity of money.
B)the velocity of money will decrease.
C)the velocity of money will increase.
D)the effect on the velocity of money cannot be determined.

Question 65

The rise of near money complicates monetary policy because:

A)it can be used both as a medium of exchange and as a store of value.
B)interest may be earned on checking accounts.
C)the velocity of any one definition of money becomes unstable.
D)holders of mutual funds may write checks on their accounts.

Question 66

One factor contributing to the increased instability of money demand is:

A)targeting the federal funds rate.
B)the increased instability of the monetary base.
C)the existence of near monies.
D)more frequent open-market purchases.

Question 67

According to the Baumol-Tobin model, an increase in the fixed costs of going to the bank will the demand for money.

A)increase
B)decrease
C)not change
D)possibly increase or decrease

Question 68

Assume that the monetary base (B) is $100 billion, the reserve-deposit ratio (rr) is 0.1, and the currency-deposit ratio
(cr) is 0.1.
a. What is the money supply?
b. If rr changes to 0.2, but cr is 0.1 and B is unchanged, what is the money supply?
c. If rr is 0.1 and cr is 0.2, but B is unchanged, what is the money supply?

Question 69

In the Baumol-Tobin theory of the transactions demand for money, the number of trips to the bank will:

A)increase as the interest rate decreases.
B)increase as the interest rate increases.
C)decrease as expenditure increases.
D)increase as wealth increases.

Question 70

As interest rates increase, people economize on their holdings of currency relative to other types of bank deposits, and banks economize on their holdings of reserves relative to deposits.
a. Using the monetary base-money multiplier framework, explain how the money supply changes as interest rates increase.
b. Graphically illustrate money supply and money demand when the nominal interest rate is on the vertical axis and the quantity of money is on the horizontal axis.

Question 71

As the U.S. economy approached the millennium, January 1, 2000, many people cautiously began to hold larger than normal quantities of currency as protection against a possible disruption of banking services that could result from computer glitches.
a. How did this greater preference for currency affect the money supply?
b. What was the impact on output?
c. How could the Federal Reserve offset such an increase in currency preferences?

Question 72

According to the Baumol-Tobin model, an increase in the interest rate the demand for money, and an increase in expenditures the demand for money.

A)increases; increases
B)increases; decreases
C)decreases; increases
D)decreases; decreases

Question 73

According to the Baumol-Tobin model, the demand for money will increase if:

A)automatic teller machines become more readily available.
B)Internet banking becomes widely available.
C)bank service charges increase.
D)real wages decrease.

Question 74

If the monetary base fell and the currency-deposit ratio rose but the reserve-deposit ratio remained the same, then:

A)the money supply would fall, but not by as much as it would have fallen if the reserve-deposit ratio had risen.
B)the money supply would fall, but not by as much as it would have fallen if the reserve-deposit ratio had fallen.
C)the money supply would fall more than it would have fallen if the reserve-deposit ratio had
D)risen. it is impossible to be certain whether the money supply would fall or rise in this case.

Question 75

In the Baumol-Tobin model, if the nominal interest rate is 0.05, the cost of trips to the bank is $12, and expenditures equals $48,000, then average money holdings equal:

A)$980.
B)$2,400.
C)$3,394.
D)$4,000.

Question 76

Some economists have advocated replacing government deposit insurance with 100-percent- reserve banking. Under this plan, banks would hold all deposits as reserves. Deposit insurance would no longer be necessary, because banks would always have the reserves to meet customer withdrawals.
a. What would happen to the money supply (defined as currency and bank deposits) in the transition from fractional reserve to 100-percent reserve, if this plan were implemented, holding other factors constant?
b.What will be the value of the money multiplier?

Question 77

In the Baumol-Tobin model, the benefit of holding money is:

A)the interest forgone.
B)convenience.
C)the lower risk and higher return compared to other assets.
D)the interest elasticity of money demand.

Question 78

Compare the portfolio approach to the demand for money and the transaction approach to the demand for money. a. On which function of money does each approach focus?
b. Which measures of money are most suited to the approach?
c. What variables are important in determining money demand?

Question 79

Under the policy of interest rate targeting adopted by the Federal Reserve in the 1990s, the money supply is:

A)increased at a constant rate.
B)decreased at a constant rate.
C)held constant.
D)allowed to fluctuate.

Question 80

In the Baumol-Tobin model, the optimal number of trips to the bank is determined by minimizing the total costs of holding money that are the:

A)forgone interest.
B)costs of trips to the bank.
C)forgone interest plus the costs of trips to the bank.
D)costs of trips to the bank minus the forgone interest.