Deck 10: The Money Supply and the Federal Reserve System

Question 1

Discuss the role of financial intermediaries in the economy.

Answer 1

Financial intermediaries are banks and other institutions that act as a link between those who have money to lend and those who want to borrow money.

Question 2

Write out in equation form the four major components of M1.

Answer 2

M1 = currency held outside banks + demand deposits + traveler's checks + other checkable deposits

Question 3

Why are savings deposits and money market accounts classified as near monies?

Answer 3

Because they are relatively liquid financial assets that are not used as a medium of exchange, but which can be quickly and easily converted to money with little or no loss of value.

Question 4

Write out in equation form the four components of M2.

Question 5

Explain what currency debasement is.

Question 6

List and explain the three characteristics of money.

Question 7

"Debasement" is sometimes used to refer to the tendency of silver or gold coins to be "shaved", that is, to have small amounts shaved off the edges of the coins by government, thereby reducing the actual silver content of the coin. Compare and contrast this practice with the definition provided by the textbook authors of the word debasement which is "the decrease in the value of money that occurs when its supply is increased rapidly."

Question 8

Prior to the passage of the Depository Institutions Deregulation and Monetary Control Act many banks used to offer toasters or blenders to prospective customers to encourage them to open checking accounts. Can you think of a reason why this practice was so prevalent prior to the passage of this law but has completely faded away since?

Question 9

Explain the difference between commodity monies, fiat money, and legal tender.

Question 10

Explain what happens to the value of M2 if the public withdraws $1 million worth of cash from the banking system.

Question 11

Explain why even a large withdrawal of money from a commercial bank would not affect the money supply.

Question 12

If Bob makes a deposit of $1000 into his checking account at his bank, explain what happens to the value of M1.

Question 13

Explain what near monies are.

Question 14

If Bob withdraws $1000 in cash from his checking account at his bank, explain what happens to the value of M1.

Question 15

Compare and contrast fiat money and commodity money.

Question 16

Explain how and why a mortgage company would qualify as a financial intermediary.

Question 17

Assume that citizens of foreign countries exchange their home currencies for American dollars and keep the cash hidden in their homes as a means of savings. Explain what happens to the effective size of the money supply.

Question 18

Explain the purpose of the Depository Institutions Deregulation and Monetary Control Act.

Question 19

Explain what happens to the value of M2 if the public makes $1 million worth of cash deposits in the banking system.

Question 20

Answer the questions below using the following information:
All figures are in billions of dollars.
a. What is the value of M1?
b. What is the value of M2?

Question 21

Explain why a full scaale bank run on even the most healthiest bank in the country could hasten its collapse.

Question 22

Assume there is only one bank in Maldavia-The First National Bank. The required reserve ratio is 25%. The First National Bank is loaned up. Use a balance sheet for First National Bank to show the effect of a new deposit of $200 million. Assume there is no leakage from the banking system. What is the value of the money multiplier in Maldavia? By how much does the money supply increase in Maldavia?

Question 23

Define a financial intermediary.

Question 24

Suppose that a group of farmers form a cooperative in which they deposit all of their grain in a common warehouse elevator and are given a receipt for their deposits. After a period of time the manager of the cooperative notices that very few farmers are returning to the warehouse to redeem their grain. What do you suppose is going on here? Furthermore, suppose that someone who is not a member of the cooperative decided to borrow some grain but was willing to take a receipt instead of the grain. How is this example similar to the story in the text about the goldsmiths? What would happen if everyone returned to the cooperative to demand their grain all at once.

Question 25

What is transactions money (M1)? Identify the components of transactions money.

Question 26

Explain what will happen to the size of both M1 and M2 in each of the following situations:
(a) Jane, a millionaire, withdraws $500,000 from her money market account to buy a famous painting.
(b) Paul transfers $10,000 from his NOW account to his savings account.
(c) Sarah takes $5,000 out of her checking account to buy IBM stock.

Question 27

What are liabilities of commercial banks and why are they liabilities.

Question 28

Explain the money creation process.

Question 29

The required reserve ratio is 10%. Dollar Bank has $50,000 in deposits and $10,000 in reserves. Assume all other commercial banks are loaned up.
(a) What is the value of this bank's excess reserves?
(b) What is the value of the additional loans that can be made by the commercial banking system?
(c) What is the money multiplier?
(d) How much in total deposits will be supported by Dollar Bank's reserves, if this bank lends all its excess reserves and there is no leakage from the banking system?

Question 30

Using the balance sheet below for a commercial bank explain how much if any this bank can expand it's lending if the required reserve ratio is 20%.

Question 31

Explain what bank runs are and why fear serves to reinforce them. Explain where the fear may originate.

Question 32

Why are loans considered to be assets to banks while they are considered liabilities for the rest of the general public?

Question 33

Why is it not sufficient for money to be considered as money merely by government fiat? Explain.

Question 34

Explain why a market structure in which money is used as a medium of exchange is more conducive to the expansion of trade and exchange than a barter system.

Question 35

Comment on the following statement "Due to fractional reserve banking, in aggregate, all lenders and borrowers are insolvent."

Question 36

Why do you suppose that vault cash would not be considered as part of the money supply as defined by M1?

Question 37

In many casinos around the country gambling chips or poker chips can be used not only to make bets but also to pay for hotel accommodations, drinks, dinner and a whole host of items that casinos sell. While this seems to fit the definition of money why are its limitations that disqualify it from giving it this classification?

Question 38

What is money? Explain the three functions that money performs. Which one is the primary function of money?

Question 39

The early Romans used salt as money. Why do you think it served so readily as a medium of exchange then and why do you think that it is not useful for that purpose today.

Question 40

What are the assets of commercial banks and why are they classified as assets?

Question 41

Assume there is an economy with a single bank, and the central bank sets the reserve requirement ratio at 10%. Assume also that the only bank had no transactions (i.e., no loans, reserves, or deposits) prior to an individual who deposits $1000 of currency with the bank.

Question 42

Explain each of the following accounting concepts: assets, liabilities and net worth.

Question 43

Explain how the existence of currency and excess reserves would affect the size of the money multiplier.

Question 44

Explain what is meant by the money multiplier. Include in your answer a discussion of what variable (s) affects the size of the money multiplier.

Question 45

Assume that a banking system starts from scratch with the following characteristics. The first bank has $100 in cash deposits which automatically count as reserves. The banking system has a required reserve ratio of 20% and all banks must lend out their excess reserves. Additionally, a check must be drawn in the full amount of the loan and deposited with another bank. Draw the modified balance sheet for Bank #1 and the balance sheet of the second bank in the process and show what happens to loan creation, reserves and demand deposits. Explain what should happen to the second bank. Below is the balance sheet for Bank #1:

Question 46

Suppose that a significant number of U.S. banks have call features in their loans that permit them to force borrowers to immediately pay back their outstanding balances. Whether or not borrowers could fully make good on this request, what would be the impact on the money supply even if they tried?

Question 47

Assume that banks become more conservative and begin to hold excess reserves instead of lending them out. How would the money multiplier in this situation compare to the case where (an amount equivalent to) all excess reserves are lent out? How will this behavior affect the Fed's behavior.

Question 48

What are the opportunity costs of holding excess reserves?

Question 49

If the required reserve ratio is 20% and a bank has $1 million in demand deposits, how much reserves must the bank keep with the Federal Reserve Bank?

Question 50

Discuss what role banks play in the money creation process.

Question 51

In terms of a bank's or a company's balance sheet what is meant by the statement that "the books always balance?"

Question 52

Assume a bank receives large deposits of checks. This of course increases the amount of its reserves. However, why does this not increase its lending potential by the full amount of these deposits?

Question 53

Suppose there are $10 million in excess reserves in the banking system and the required reserve ratio is 10%. By how much could the money supply expand?

Question 54

In July of 2008 federal regulators seized IndyMac in what the government called the second largest bank failure in U.S. history. Many customers stood in long lines outside the bank to withdraw their money. Explain why it is important for banks to keep excess reserves even though keeping too much is costly because they don't earn interest for the bank.

Question 55

When banks foreclose on homeowners who are either unable or unwilling to pay back their loans in a timely fashion they often take these homes and put them up for sale in an attempt to get back part of the principal that was loaned out in the first place. Does this have the same effect on the money supply as when a bank calls back a loan from a borrower before it matures? Why or why not?

Question 56

What is a run on a bank? What safeguards have been instituted to reduce the likelihood of a run on a bank?

Question 57

Assume the Bank of Smithville opens its doors to depositors and receives $100,000 in cash deposits. Assume furthermore that the bank has to abide by a 20% reserve ratio. Could this bank make a loan in the amount of $90,000?

Question 58

Define bank reserves.

Question 59

Define excess reserves.

Question 60

Discuss the money multiplier. Assume that the banking system's total excess reserves total $20 million and that the required reserve ratio is 25%. Calculate the money multiplier and the total potential expansion of the nation's money supply.

Question 61

Explain the Fed's function as a lender of last resort.

Question 62

Assume that the money supply increases from $1.5 trillion to $1.6 trillion. Give at least one explanation which could have caused this increase.
Any one of the following would be acceptable answers:

Question 63

Assume the banking system has $100 billion in demand deposits and $10 billion in reserves. In addition, assume that the required reserve ratio is 5%. Answer the following questions:
a. How much excess reserves are in this system?
b. What is the value of the money multiplier?
c. What is the maximum amount of change in demand deposit creation that could take place if the banking system lent out all of its excess reserves.

Question 64

Write a balance sheet for the Federal Reserve and list possible items on both sides. Do not worry about recording actual dollar figures.

Question 65

Explain why the discount rate would be considered and administratively-determined interest rate rather than a market interest rate.

Question 66

Explain the discount rate.

Question 67

Explain how the Federal Reserve clears interbank payments.

Question 68

Assume the following balance sheet for the Federal Reserve and commercial banks. If the required reserve ratio is 10% and the commercial banks borrow and additional $100 billion show the effect on the balance sheet of the commercial banks and the Federal Reserve. Explain the impact on the money supply.

Question 69

Explain why the discount rate cannot be used to control the money supply with great precision.

Question 70

Explain why a high discount rate might limit commercial bank borrowing from the Federal Reserve but very low discount rate may not encourage very much borrowing. What circumstances can you think of in which this would be true?

Question 71

What are the two reasons that the Federal Reserve acts as a "lender of last resort?"

Question 72

Assume the following balance sheet for the Federal Reserve and the commercial banks with a required reserve ratio of 10%. Suppose the Fed wishes to expand the money supply by reducing the ratio to 5%. Draw a new balance sheet for the commercial banks and explain the changes. All figures are in billions of dollars

Question 73

Apart from the major functions of the Fed, are there other duties assigned to it? Explain.

Question 74

Briefly discuss the structure of the Federal Reserve.

Question 75

Is it true that the Federal Reserve is an independent agency?

Question 76

List the functions of the Federal Reserve.

Question 77

What is meant by the characterization of Federal Reserve Banks as "banker's banks?"

Question 78

Fill in the following table by indicating whether the proposed Federal Reserve action will increase or decrease the money supply. If the action is not a federal reserve power then write not applicable

Question 79

Explain the Federal Open Market Committee of the Federal Reserve System.

Question 80

Explain how the Federal Reserve can increase or decrease the money supply through the manipulation of reserves.