Question 1

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:

Accepted Answer

An increase in rr means banks are holding back more reserves relative to their deposits. This decreases the amount of money that banks can lend out, and thus decreases the money supply. The constant cr and B do not affect this relationship.

Question 2

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

Accepted Answer

When the Federal Reserve conducts an open-market purchase, it buys bonds from the public. This can include individuals, banks, businesses, and other institutions.

Question 3

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

Accepted Answer

Open-market purchases involve the Federal Reserve buying securities from banks, which in turn increases the reserves of the banks. This increases the ability of banks to lend out money, which leads to an increase in the overall money supply.

Question 4

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

Accepted Answer

The ratio of the money supply to the monetary base is referred to as the money multiplier. It is the process by which an increase in the monetary base results in a larger increase in the money supply. The money multiplier is determined by the reserve requirement and the currency deposit ratio.

Question 5

For borrowing from the discount window, the Fed sets the _____ of borrowing, compared to borrowing using the Term Auction Facility, where the Fed sets the _____ of borrowing.

Accepted Answer

For borrowing from the discount window, the Fed sets the price of borrowing, meaning the interest rate at which banks can borrow. On the other hand, for borrowing using the Term Auction Facility, the Fed sets the quantity of funds available for borrowing, meaning banks bid on how much they want to borrow and the Fed sets the total amount it will lend at a given interest rate. Therefore, the correct answer is D, where the Fed sets the price (interest rate) for discount window borrowing and the quantity of funds for Term Auction Facility borrowing.

Question 6

When the Fed decreases the interest rate paid on reserves, if the ratio of currency to deposits decreases also while the monetary base is constant, then:

Accepted Answer

When the Fed decreases the interest rate paid on reserves, banks are incentivized to lend more rather than hold onto reserves, potentially increasing the money supply. Additionally, if the ratio of currency to deposits decreases, it implies that more money is being held in the form of deposits rather than currency. Since deposits can be multiplied through the banking system via loans (due to the fractional reserve banking system), this also tends to increase the money supply. Together, these actions suggest an increase in the money supply, assuming the monetary base remains constant.

Question 7

If the monetary base is denoted by B, rr is the ratio of reserves to deposits, and cr is the ratio of currency to deposits, then the money supply is equal to ______ divided by ______ multiplied by B.

Accepted Answer

The money supply is calculated as the monetary base (B) divided by the reserve ratio (rr) plus the currency ratio (cr), and then multiplied by the monetary base. This corresponds to choice B: (cr + 1) / (cr + rr) multiplied by B.

Question 8

When the Fed decreases the interest rate paid on reserves, it:

Accepted Answer

When the Fed decreases the interest rate paid on reserves, banks are less incentivized to hold excess reserves and instead lend them out, decreasing the reserve-deposit ratio. This in turn increases the money supply and decreases the interest rate in the market.

Question 9

The more funds that the Federal Reserve makes available for banks to borrow through the Term Auction Facility, the _____ the monetary base and the _____ the money supply.

Accepted Answer

When the Federal Reserve makes more funds available for banks to borrow through the Term Auction Facility, it increases the monetary base because it is directly adding to the reserves that banks hold. As banks have more reserves, they can lend more, which in turn increases the money supply through the money multiplier effect.

Question 10

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

Accepted Answer

The formula for calculating the money supply is: 
Money supply = Monetary base x Money multiplier

Using the values given in the question: 
Money supply = $400 billion x 2 
Money supply = $800 billion

Question 11

When the Fed increases the discount rate, it:

Accepted Answer

When the Federal Reserve increases the discount rate, it makes borrowing more expensive for banks. This typically leads to a decrease in the monetary base (B) because banks are less inclined to borrow reserves from the Fed, reducing the overall amount of reserves in the banking system.

Question 12

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

Accepted Answer

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

Question 13

The money supply will decrease if the:

Accepted Answer

The money supply will decrease if the currency-deposit ratio increases because more money is being held in the form of currency rather than in deposits. This reduces the base for the money multiplier effect, leading to a decrease in the overall money supply.

Question 14

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:

Accepted Answer

The money supply decreases because the money multiplier, which is 1 / (cr + rr), decreases when cr increases (assuming rr is constant). A higher currency to deposit ratio means more money is held as currency rather than deposited in banks, which reduces the base for banks to create additional money through lending.

Question 15

When banks borrow through the Term Auction Facility, the price of borrowing is determined by:

Accepted Answer

The Term Auction Facility involves a competitive bidding process in which banks bid for funds and the interest rate at which they are willing to borrow. The rate is then determined by the lowest accepted bid.

Question 16

The money supply will increase if the:

Accepted Answer

The monetary base is the total amount of reserves plus currency in circulation in the economy. If the monetary base increases, there are more reserves available for banks to lend out, which increases the money supply. An increase in the currency-deposit ratio (A) or reserve-deposit ratio (B) would decrease the money supply, while an increase in the discount rate (D) would make it more expensive for banks to borrow from the central bank and decrease lending, also decreasing the money supply.

Question 17

Two ways for banks to borrow reserves from the Federal Reserve are through:

Accepted Answer

The discount window and the Term Auction Facility are the two primary ways for banks to borrow reserves from the Federal Reserve. The discount window is the lender of last resort facility that allows eligible banks and other depository institutions to borrow funds from the Federal Reserve at a discount rate. The Term Auction Facility is a program that allows depository institutions to bid for term funds through an auction process. Open-market operations and excess reserve swaps are tools that the Federal Reserve uses to inject or withdraw reserves into or from the banking system. Decreasing the reserve-deposit ratio and the currency-deposit ratio are not ways for banks to borrow reserves from the Federal Reserve but are factors that affect the money supply. Fractional-reserve banking and financial intermediation are systems for creating credit and liquidity but are not ways for banks to borrow reserves from the Federal Reserve.

Question 18

High-powered money is another name for:

Accepted Answer

High-powered money, also known as the monetary base, includes currency in circulation and reserves held by banks at the central bank. It does not include demand deposits (choice B) or M2 (choice D).

Question 19

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

Accepted Answer

If the reserve-deposit ratio is less than one, then the money multiplier is greater than one. The money supply will increase by the monetary base times the money multiplier. Therefore, if the monetary base increases by $1 million, and the money multiplier is say 2, then the money supply will increase by $2 million.

Question 20

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

Accepted Answer

When the Federal Reserve makes an open-market sale, it sells government securities to banks, which decreases the reserves held by banks. This, in turn, decreases the money supply and the monetary base, making choice D the correct answer.

Quiz 4: The Monetary System: What It Is and How It Works