Deck 13: B : Money and the Banking System

Question 1

What advantages does a money economy have over a barter economy?

Answer 1

The existence of money substantially reduces the costs of trAnsweractions. To trade in a barter economy, you must find someone who not only wants to buy the goods that you have but who also wants to sell the goods you want to buy. This type of trading quickly becomes time consuming and costly. When money serves as a medium of exchange, specialization, division of labor, and trade are all made much easier.

Question 2

Does the Federal Reserve operate like an ordinary commercial bank? What is the Fed's job?

Answer 2

Since the Fed is an independent branch of the government, it does not operate for profit. The Fed is also the only bank that can legally issue money-the Federal Reserve notes ($1 bills, $5 bills, etc.) that we carry around in our pockets. Finally, the Fed acts as a banker's bank. Most banks hold deposits at the Fed and occasionally borrow money from the Fed. The Fed also oversees the clearing of checks through the banking system.

Question 3

What is the difference between the Treasury and the Federal Reserve? Is there any difference in the effect on the money supply between the sale of bonds by the Treasury and the sale of bonds by the Fed?

Answer 3

The Treasury and the Federal Reserve are two distinct agencies. The Treasury is responsible for the federal budget; if there is a budget deficit, the Treasury must sell bonds to the public to finance it. The Fed is responsible for the stability of the monetary and credit system for the country. It does not issue bonds to finance the federal government. When the Treasury sells bonds, there is no change in the money supply; money is just trAnswerferred from the private sector to the government sector. When the Fed sells bonds, the money supply increases because "new" money is going into circulation.

Question 4

Briefly explain the three functions of money.

Question 5

How do changes in open market operations alter the monetary base, and how do changes in the monetary base translate to changes in the money supply?

Question 6

Discuss the changes that have and will in the future affect the usefulness of the M1 and M2 money supply figures as indicators of monetary policy.

Question 7

Why is there more than one definition of the money supply? What is the difference between them?

Question 8

Explain how the Fed would use its four tools to decrease and to increase the money supply.

Question 9

You deposit a $1,000 scholarship check in the bank. If the required reserve ratio is 10 percent, explain how the banking system will create new money and how much money can potentially be created.

Question 10

What are the advantages of a fractional reserve banking system compared to a system that requires 100 percent of deposits to be kept on reserve?