Question 1

Assume that the required reserve rate is ten percent, banks want to hold excess reserves in an amount that equals three percent of deposits, and the public withdraws ten percent of every deposit in cash. An open market purchase of $1 million by the Fed will see banking system deposits increase by:

Accepted Answer

When the Fed makes an open market purchase of $1 million, the banking system reserves will increase by $1 million x 0.1 (required reserve rate) = $100,000. This will allow banks to lend out additional funds of $1 million - $100,000 = $900,000. However, banks also want to hold excess reserves equal to 3% of deposits, so they will hold back 0.03 x ($1 million + $900,000) = $57,000. This means that the total increase in deposits will be $1 million - $57,000 = $943,000. Additionally, because the public withdraws 10% of every deposit in cash, the total increase in deposits will be $943,000 x 0.9 = $848,700. Therefore, the correct answer is A, as the increase in deposits will be more than $1 million (initially lent by the Fed) but less than $10 million (without the cash withdrawal).

Question 2

The simple deposit expansion multiplier is really too simple for understanding the link between changes in a central bank's balance sheet and the quantity of money in the economy because it:

Accepted Answer

The simple deposit expansion multiplier is too simplistic because it ignores the fact that people might change their currency holdings, which can significantly affect the money supply. It assumes all money deposited will be held in banks, not accounting for the public's preference for holding cash.

Question 3

The use of deposit sweeping allows banks to:

Accepted Answer

Deposit sweeping allows banks to move excess funds from checking accounts into savings accounts, which are subject to a lower reserve requirement. This reduces the amount of required reserves the bank must hold, freeing up more money for lending or other uses.

Question 4

If we assume a ten percent required reserve rate, and banks not holding any excess reserves and no change in currency holdings, an open market sale of $5 million of U.S. Treasury securities by the Fed, will result in deposits:

Accepted Answer

A ten percent required reserve rate means that for every $1 deposited, the bank must hold $0.10 as reserves. Therefore, an open market sale of $5 million of U.S. Treasury securities by the Fed reduces the reserves of banks by $0.5 million (10% of the $5 million). Since the banks do not hold any excess reserves, this decrease in reserves will force them to reduce their deposits by $5 million (which is $50 million in deposits multiplied by the required reserve rate of 10%). Hence, deposits will decrease by $50 million.

Question 5

If required reserves are expressed by RR; the required reserve rate by rD and deposits by D, the simple deposit expansion multiplier is expressed as:

Accepted Answer

The simple deposit expansion multiplier is expressed as 1/rD, where rD is the required reserve rate. This formula calculates how much the money supply can increase based on the initial deposit and the reserve requirement.

Question 6

If M = the quantity of money, m, the money multiplier, MB, the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR = required reserves, and ER = Excess reserves, then C + R would equal:

Accepted Answer

The reserve requirement ratio (RR), which determines the required reserves, is multiplied by deposits (D) to give required reserves (RR x D). Excess reserves (ER) equals reserves (R) minus required reserves (RR x D). The money multiplier (m) is calculated as 1/RR. Therefore, M = m x MB, where MB is the monetary base. Since MB = C + R, then C + R would equal the monetary base (MB) and is the correct answer.

Question 7

During the Great Depression, the monetary base in the U.S.:

Accepted Answer

During the Great Depression, the monetary base in the U.S. actually increased, contrary to what might be expected during a period of economic downturn. This was largely due to the Federal Reserve's efforts to inject liquidity into the banking system.

Question 8

If we focus on the banking system and assume no change in the public's currency holdings, a loss of reserves by any one bank must:

Accepted Answer

The question assumes no change in the public's currency holdings, which means that there is no inflow or outflow of currency between banks and the public. Therefore, any loss of reserves by one bank can be offset by gains in reserves by other banks in the system. This means that the loss of reserves by one bank does not necessarily equal the loss of reserves by the entire system. It also does not necessarily result in a net loss of reserves for the banking system. The correct answer is C, which states that a loss of reserves by any one bank would result in no change in reserves for the banking system.

Question 9

If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR = required reserves, and ER = excess reserves, then m would equal:

Accepted Answer

The money multiplier (m) is the ratio of the change in the quantity of money (M) to the change in the monetary base (MB). Therefore, m = M/MB.

Question 10

If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR = required reserves, and ER = Excess reserves, then RR would equal:

Accepted Answer

Required reserves (RR) are the portion of deposits that banks are required to hold as reserves, which can be calculated as RR = R - ER, where R is the total reserves and ER is the excess reserves that banks may choose to hold above the required amount. Therefore, D and C are not relevant in calculating RR, and M/MB is not the correct formula for calculating required reserves. MB is the monetary base which includes currency in circulation and reserves held by banks with the central bank.

Question 11

The formula for required reserves is:

Accepted Answer

The formula for required reserves is given by multiplying the reserve ratio (rD) by the total deposits (D), hence the correct formula is rD.

Question 12

Which of the following best completes the statement? If people increase their currency holdings, all else the same, the monetary base:

Accepted Answer

The monetary base does not change because it consists of currency in circulation and reserves, which are not affected by the public's preference for holding currency. However, M2 decreases because it includes savings deposits and other near-money assets, which are reduced when people hold more currency.

Question 13

If there were an increase in the number of bank failures, we should expect the amount of excess reserves in the banking system to:

Accepted Answer

When there is an increase in the number of bank failures, other banks in the system often become more cautious, holding onto more reserves to protect themselves against potential losses or runs on the bank. This behavior leads to an increase in the amount of excess reserves in the banking system as banks aim to ensure they have enough liquidity to meet any sudden increase in withdrawals.

Question 14

If the Fed were to increase the required reserve rate from ten percent to twenty percent, the simple deposit expansion multiplier would:

Accepted Answer

The simple deposit expansion multiplier is the reciprocal of the required reserve ratio. Increasing the required reserve ratio from 10% (1/10) to 20% (1/5) would halve the multiplier, making it half as large as before.

Question 15

During the early years of the Great Depression, a study of the money aggregates reveals that the money multiplier:

Accepted Answer

During the early years of the Great Depression, the money multiplier decreased. This can be attributed to a decrease in the money supply, as banks had to call in loans and reduce lending due to increasing default rates and a lack of confidence in the stability of the banking system. This decrease in the money supply led to a decrease in the velocity of money and a further contraction of the economy.

Question 16

If the Fed were to decrease the required reserve rate from ten percent to five percent, the simple deposit expansion multiplier would:

Accepted Answer

The simple deposit expansion multiplier is 1/RR. If RR decreases from 10% to 5%, then the multiplier would increase from 10 to 20, which is a doubling of the multiplier.

Question 17

If the required reserve rate is ten percent and banks do not hold any excess reserves and there are no changes in currency holdings, a $1 million open market purchase by the Fed will result in what change in loans?

Accepted Answer

The required reserve ratio is 10%, so if the Fed purchases $1 million in bonds, banks are able to lend out an additional $10 million. Therefore, there is an increase in loans of $10 million.

Question 18

If the required reserve rate is ten percent and banks do not hold any excess reserves and there are no changes in currency holdings, a $1 million open market purchase by the Fed will result in deposit creation of:

Accepted Answer

When the Fed purchases $1 million worth of securities from the market, it pays for the securities by crediting the seller's bank account with $1 million in reserves. Since the required reserve rate is 10%, the bank is required to hold $100,000 ($1 million x 0.10) in reserves and can lend out the remaining $900,000. As this $900,000 is deposited into other banks, and those banks are also required to hold 10% of deposits as reserves, the process repeats. The initial $1 million injected into the banking system can create up to $10 million in deposits (i.e., $1 million ÷ 0.10). Therefore, the correct answer is C) $10 million.

Question 19

During the early years of the Great Depression, the monetary base and M2:

Accepted Answer

During the early years of the Great Depression, the monetary base increased as the Federal Reserve tried to inject liquidity into the banking system. However, M2, which includes savings and checking deposits among other components, decreased because people were withdrawing their money from banks in fear of bank failures, leading to a contraction in the broader money supply despite the increase in the monetary base.

Question 20

The money multiplier is much lower today than it was twenty-five years ago because:

Accepted Answer

The money multiplier is determined by the currency-to-deposit ratio, and if this ratio is higher, the money multiplier will be lower. This is because banks have less currency to lend out relative to deposits. Therefore, as the currency-to-deposit ratio has increased in the past twenty-five years, the money multiplier has decreased.

Quiz 17: The Central Bank Balance Sheet and the Money Supply Process