Question 1

The money multiplier is greater than one because banks:

Accepted Answer

Banks hold only a fraction of deposits as reserves and lend out the rest as loans. This allows multiple individuals to have access to the original deposit, creating a multiplier effect on the money supply.

Question 2

The money multiplier equals one:

Accepted Answer

The money multiplier is calculated as the inverse of the reserve ratio, which is 1 divided by the reserve ratio.

Question 3

If banks keep one-eighth of their deposits in the form of reserves, and the Fed credits Alex's bank account with $8,000, how much does the money supply increase?

Accepted Answer

The reserve ratio is 1/8, so the money multiplier is 8. The initial deposit of $8,000 can increase the money supply by $8,000 * 8 = $64,000.

Question 4

The effective reserve ratio is determined primarily by:

Accepted Answer

The effective reserve ratio is the percentage of deposits held by a bank as reserves, which the bank can use to meet customer withdrawals and other obligations. Banks will set their desired reserve ratio based on their need for liquidity, which is influenced by factors such as the demand for loans and their level of risk aversion. Therefore, the effective reserve ratio is primarily determined by how liquid banks wish to be.

Question 5

If the reserve ratio is 10%, then a $100 increase in bank deposits can potentially lead to:

Accepted Answer

The reserve ratio is the percentage of deposits banks are required to hold in reserve. With a reserve ratio of 10%, banks are required to hold $10 of every $100 deposited. This means that they can loan out $90, which will eventually be deposited somewhere else, creating a cycle of lending and depositing. As a result, a $100 increase in deposits could potentially lead to a $1,000 increase in the money supply (10 times the initial deposit).

Question 6

The required reserve ratio is determined by how:

Accepted Answer

The required reserve ratio is determined by the Federal Reserve, not by how much lending banks wish to engage in or how liquid banks wish to be. The ratio is set as a tool for the Fed to control the money supply and regulate the economy. Active capital markets may have an impact on bank lending, but they do not directly determine the required reserve ratio.

Question 7

If $1 in cash is held in reserve for every $20 of deposits, the reserve ratio is:

Accepted Answer

The reserve ratio is the fraction of deposits that banks hold in reserve. Since banks hold $1 in cash for every $20 of deposits, the fraction is $\frac{1}{20}$. To convert this to a percentage, we multiply by 100. $\frac{1}{20} 	imes 100 = 5\%$, so the answer is choice (C).

Question 8

If the reserve ratio is 5%, then an increase in bank deposits by $100,000 could expand the money supply by:

Accepted Answer

The answer of If the reserve ratio is 5%, then...

Question 9

If the average reserve ratio in the banking system is 20% and the Fed increases bank reserves by $100,000, what will be the total potential increase in the money supply?

Accepted Answer

The money multiplier is 1 divided by the reserve ratio, so 1/0.20 = 5. The total potential increase in the money supply is the increase in reserves multiplied by the money multiplier: $100,000 * 5 = $500,000.

Question 10

Under fractional reserve banking, banks hold:

Accepted Answer

Under fractional reserve banking, banks are required to hold only a fraction of the deposits in reserve (usually a percentage set by the central bank of a country) and can lend out the rest while maintaining enough cash to meet customer demand for withdrawals. This system allows banks to create money through lending and is used widely in modern banking systems.

Question 11

Under fractional reserve banking, banks:

Accepted Answer

Fractional reserve banking is a system in which banks hold only a fraction of deposits in reserve, lending out the rest. This allows banks to make loans and essentially create new money, but it also creates the risk of bank runs if too many depositors demand their money back at once.

Question 12

Because the United States has a fractional reserve banking system, banks hold:

Accepted Answer

The United States has a fractional reserve banking system, which means that banks are required to hold only a fraction of their deposits as reserves while the rest can be loaned out to customers. This fraction is determined by the reserve requirement set by the Federal Reserve, which is currently around 10%. Therefore, banks hold less than 100% of deposits as reserves.

Question 13

As market interest rates rise:

Accepted Answer

As market interest rates rise, banks will earn a higher return on their loans and other investments. This increases the opportunity cost of holding reserves, since the interest earned on reserves is likely to be lower than what the bank could earn by making loans or investing in other assets. As a result, banks may be more likely to lend out their reserves and less likely to hold excess reserves. However, this does not necessarily mean that fewer loans will be extended or that the money multiplier will fall, as those factors are influenced by a variety of other factors besides interest rates.

Question 14

If the Fed credits Alex's checking account with $8,000 and Alex's bank decides to keep the entire $8,000 in the form of reserves instead of lending it out, how much does the money supply increase?

Accepted Answer

The money supply increases by the amount credited to Alex's account, which is $8,000, because the bank is not lending it out to create additional money through the money multiplier effect.

Question 15

The reserve ratio (RR) is the:

Accepted Answer

The reserve ratio (RR) is the ratio of reserves (amount of deposits held by banks in accounts with the central bank) to deposits (total amount of money deposited by customers in the bank).

Question 16

If a $500 increase in reserves ultimately leads to a $2,000 increase in the money supply, the money multiplier is:

Accepted Answer

The money multiplier is calculated as the ratio of the change in the money supply to the change in reserves. In this case, the money multiplier would be 2,000/500 = 4.

Question 17

The money multiplier (MM) is the:

Accepted Answer

The money multiplier (MM) is the amount that the money supply expands with each dollar increase in reserves. It reflects how much the money supply can increase based on the reserve ratio set by the central bank.

Question 18

If the reserve ratio is 20%, the money multiplier equals:

Accepted Answer

The money multiplier is defined as 1/reserve ratio. Therefore, if the reserve ratio is 20%, the money multiplier would be 1/0.2, which equals 5.

Question 19

An increase in the reserve ratio will _____ banks' ability to make loans.

Accepted Answer

An increase in the reserve ratio will require banks to hold more reserves, reducing the amount of funds available for lending, and decreasing their ability to make loans.

Question 20

As the reserve ratio rises:

Accepted Answer

As the reserve ratio rises, banks are required to hold more of their deposits in reserve and have less money to lend out. This decreases the money multiplier, which is the amount of money the banking system can create through the process of fractional reserve banking. Therefore, C is the correct choice. A, B, and D are incorrect because they do not accurately describe the effects of an increase in the reserve ratio.

Quiz 15: The Federal Reserve System and Open Market Operations