Question 1

If the required reserve ratio is 0.2,and the Fed buys $3,000 of U.S.government securities,the maximum amount by which the money supply can increase is:

Accepted Answer

When the Fed buys $3,000 of U.S. government securities, this initial transaction increases the reserves of the banking system by $3,000. With a required reserve ratio of 0.2 (or 20%), banks are required to hold 20% of deposits as reserves and can lend out the remaining 80%. The money multiplier formula is 1/required reserve ratio, which in this case is 1/0.2 = 5. Therefore, the maximum increase in the money supply is $3,000 * 5 = $15,000.

Question 2

The simple money multiplier:

Accepted Answer

The simple money multiplier is defined as the reciprocal of the required reserve ratio. This means that as the required reserve ratio decreases, the simple money multiplier increases, and as the required reserve ratio increases, the simple money multiplier decreases. The other options are incorrect.

Question 3

Which of the following would likely increase the money supply?

Accepted Answer

When the Fed buys government securities from banks, it increases the reserves of those banks, allowing them to lend more, which increases the money supply.

Question 4

If the required reserve ratio is 10 percent and the Fed buys a $5,000 security from a depository institution,the money supply:

Accepted Answer

When the Fed buys a $5,000 security from a depository institution, it directly increases the reserves of that institution by $5,000. With a 10 percent required reserve ratio, this initial increase in reserves can support a total increase in the money supply of up to $50,000, because each dollar of reserves can support $10 of deposits ($5,000 x 10 = $50,000), following the money multiplier effect (1/required reserve ratio).

Question 5

If r is the required reserve ratio,which of the following is the simple money multiplier?

Accepted Answer

The simple money multiplier is calculated as 1/r, where r is the required reserve ratio. This multiplier indicates how much the money supply can potentially increase with each deposit into the banking system, given the reserve requirement.

Question 6

Suppose checking deposits increase by $6,000 after all rounds of the money-creation process when the Fed buys $1,200 worth of U.S.government securities.This implies that the maximum value of the required reserve ratio is:

Accepted Answer

First, we need to understand the process of money creation when the Fed buys government securities:

1. The Fed buys $1,200 worth of government securities from a bank.
2. The bank receives $1,200 in reserves from the Fed, increasing its total reserves.
3. The bank can then make loans and create new checking deposits based on the required reserve ratio.
4. Assuming a required reserve ratio of 20% (which means the bank must hold 20% of its deposits as reserves), the bank can create new checking deposits equal to $6,000 (the increase in checking deposits) / (1 - 0.2) = $7,500.
5. The total increase in the money supply is $7,500 - $1,200 = $6,300.

Now, we can solve for the maximum value of the required reserve ratio by using the same process and assuming different values for the required reserve ratio:

1. If the required reserve ratio is 100%, then the bank cannot create any new checking deposits and the increase in the money supply would only be $1,200. This is less than the actual increase of $6,000, so the required reserve ratio must be less than 100%.
2. If the required reserve ratio is 50%, then the bank can create new checking deposits equal to $6,000 / (1 - 0.5) = $12,000. This is greater than the actual increase of $6,000, so the required reserve ratio must be greater than 50%.
3. If the required reserve ratio is 25%, then the bank can create new checking deposits equal to $6,000 / (1 - 0.25) = $8,000. This is still greater than the actual increase of $6,000, so the required reserve ratio must be greater than 25%.
4. If the required reserve ratio is 20%, then the bank can create new checking deposits equal to $6,000 / (1 - 0.2) = $7,500. This is equal to the actual increase of $6,000, so the required reserve ratio must be 20% or less.
5. If the required reserve ratio is 15%, then the bank can create new checking deposits equal to $6,000 / (1 - 0.15) = $7,059. This is still greater than the actual increase of $6,000, so the required reserve ratio must be less than 15%.

Therefore, the maximum value of the required reserve ratio is 20%, which is choice C.

Question 7

The table below shows the balance sheet of Countybank.Which of the following transactions is most likely to have just taken place at Countybank?
Table 14.2
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COUNTYBANK
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$\begin{array}{|l|l|l|l|}
\hline\text { Assets } && \text { Liabilities and Net Worth } \
\hline & & \
\hline \text { Cash } & \$ 1,000 & \text { Checkable deposits }&\$1,000\\hline
\end{array}$

Accepted Answer

The balance sheet shows an increase in both cash and checkable deposits by $1,000, indicating a deposit into a checking account.

Question 8

The table below shows the balance sheet of Countybank.If the required reserve ratio is 10 percent,this bank alone can now increase its lending by _____.
Table 14.2
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COUNTYBANK
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$\begin{array}{|l|l|l|l|}
\hline\text { Assets } && \text { Liabilities and Net Worth } \
\hline & & \
\hline \text { Cash } & \$ 1,000 & \text { Checkable deposits }&\$1,000\\hline
\end{array}$

Accepted Answer

Given a required reserve ratio of 10%, Countybank must keep 10% of its checkable deposits as reserves. With checkable deposits of $1,000, the required reserves are $100 (10% of $1,000). Since the bank has $1,000 in cash (assets), it can use the excess over the required reserves for lending. The excess reserves are $900 ($1,000 in cash - $100 required reserves), which is the amount the bank can now increase its lending by.

Question 9

If an increase of $10 million in excess reserves increases checkable deposits in the banking system by a maximum of $200 million,the required reserve ratio is:

Accepted Answer

The required reserve ratio can be calculated using the money multiplier formula, which is 1/required reserve ratio. Given that a $10 million increase in excess reserves leads to a $200 million increase in checkable deposits, the multiplier is 200/10 = 20. Therefore, the required reserve ratio is 1/20 = 0.05 or 5 percent.

Question 10

If the Fed purchases government securities in the open market,_____.

Accepted Answer

When the Fed purchases government securities in the open market, it pays for them by crediting the seller's account at a commercial bank. This increases the reserves of the commercial bank, and it can then potentially lend out a portion of these reserves, leading to an increase in the money supply. This process can occur regardless of who the seller of the securities is. Therefore, the correct answer is E.

Question 11

If the simple money multiplier is 5,the required reserve ratio must be equal to _____.

Accepted Answer

The simple money multiplier is the reciprocal of the required reserve ratio. If the multiplier is 5, the reserve ratio is 1/5, which is 20 percent.

Question 12

Which of the following essential factors enables commercial banks to create money?

Accepted Answer

Commercial banks can create money by using excess reserves to issue loans and by the process of deposit multiplication. When banks issue loans, the borrowed money is credited to the borrower's account, which increases the bank's liabilities and also its assets, as it now has a claim on the borrower's repayments. This increases the bank's excess reserves, which it can then use to issue more loans, leading to further deposit multiplication and money creation. Required reserves, state and local government securities, U.S. government securities, and net worth are all important factors for banks, but they are not directly related to the process of creating money through lending activities.

Question 13

The Reserve Bank of Glassen is the apex banking institution in the country of Glassen.Money supply in Glassen will increase when:

Accepted Answer

When the Reserve Bank of Glassen buys bonds from commercial banks, it increases the money supply in the economy as it injects new money into the system. This is known as an expansionary monetary policy. The other choices would actually decrease the money supply or have no impact on it. Increasing the required reserve ratio for commercial banks would reduce the amount of money they can lend out and therefore decrease the money supply. Selling government bonds to commercial banks would also decrease the money supply as the banks would have less money to lend out. Raising the discount rate for commercial banks would discourage them from borrowing from the central bank and therefore reduce the amount of money they can lend out. Printing new checks on its own does not increase the money supply unless they are backed by assets such as gold or foreign currency.

Question 14

If the required reserve ratio is 20 percent and the Fed buys a $10,000 security from a depository institution that currently has no excess reserves,the money supply:

Accepted Answer

When the Fed buys a $10,000 security from a depository institution, it injects $10,000 into the banking system. With a 20 percent reserve requirement, banks are required to hold 20% of deposits as reserves but can lend out the remaining 80%. This initial $10,000 can theoretically support up to $50,000 in new money creation through the money multiplier effect, as each dollar deposited can be lent out multiple times, with each round of lending being only 80% of the previous round due to the 20% reserve requirement. This process increases the money supply by $50,000.

Question 15

Money expansion stops when new reserves introduced into the banking system have been converted into:

Accepted Answer

When new reserves are introduced into the banking system, banks are required to hold a certain percentage of those reserves as required reserves. Once the banks have fulfilled this requirement, any remaining reserves can be loaned out, resulting in a multiplication effect and expansion of the money supply. However, once all new reserves have been converted into required reserves, there is no further potential for money expansion.

Question 16

The banking system creates money in the sense that it:

Accepted Answer

Banks create money through the process of lending. When banks provide loans, they do not physically print money but create deposits in the borrower's account, effectively increasing the money supply. This process is based on having excess reserves, from which they can lend out, thus 'creating loans from excess reserves.'

Question 17

In the money and credit expansion process,the total change in checkable deposits is equal to the initial change in excess reserves _____.

Accepted Answer

The total change in checkable deposits is determined by the multiplier effect, which is equal to the reciprocal of the required reserve ratio. Therefore, the initial change in excess reserves must be multiplied by the reciprocal of the required reserve ratio to determine the total change in checkable deposits.

Question 18

Suppose the reserve requirement is 15 percent.Which of the following is true?

Accepted Answer

The simple money multiplier is calculated as the reciprocal of the reserve requirement ratio. With a reserve requirement of 15 percent (or 0.15), the simple money multiplier is 1 divided by 0.15, which is 1/0.15.

Question 19

The table below shows the balance sheet of Eubank.If the interest rate on loans is 10 percent,the annual cost to Eubank of holding excess reserves is:
Table 14.1
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EUBANK
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$$\begin{array} { | l | r | r | r | } 
\hline \text { Assets } &  { \text { Liabilities and Net Worth } } & \
\hline & & & \
\hline \text { Deposits at the Fed } & \$ 40,000 & \text { Checkable deposits } & \$ 500,000 \
\hline \text { Cash } & \$ 10,000 & \text { Net Worth } & \$ 20,000 \
\hline \text { Loans } & \$ 300,000 & & \
\hline \text { Securities } & \$ 150,000 & & \
\hline \text { Fed Stock } & \$ 20,000 & & \
\hline
\end{array}$$

Accepted Answer

The annual cost of holding excess reserves is calculated by applying the interest rate to the amount of excess reserves. Since the question specifies a 10 percent interest rate, the correct answer involves applying this rate to the excess reserves, not to the total deposits, net worth, or any other figure.

Question 20

The money expansion process continues until there are no more:

Accepted Answer

The money expansion process relies on banks being willing to lend out their excess reserves. Once all excess reserves have been lent out, the process cannot continue. Therefore, the correct answer is C) excess reserves in the system that banks are willing to lend.

Quiz 14: Banking and the Money Supply