Question 1

In a fractional-reserve banking system with no excess reserves and no currency holdings, if the central bank buys $100 million worth of bonds,
A) reserves and the money supply increase by less than $100 million.
B) reserves increase by $100 million and the money supply increases by $100 million.
C) reserves increase by $100 million and the money supply increases by more than $100 million.
D) both reserves and the money supply increase by more than $100 million.

Accepted Answer

When the central bank buys $100 million worth of bonds, the bank credits the account of the seller of the bonds (usually a commercial bank). This increases both the reserves held by the commercial bank and its ability to create loans. The commercial bank can then loan out a portion of the $100 million it received from the central bank. As a result, the money supply increases by more than $100 million.

Question 2

If the reserve ratio is 5 percent, banks do not hold excess reserves, and people do not hold currency, then when the Fed purchases $20 million worth of government bonds, bank reserves
A) increase by $20 million and the money supply eventually increases by $400 million.
B) decrease by $20 million and the money supply eventually decreases by $400 million.
C) increase by $20 million and the money supply eventually increases by $100 million.
D) decrease by $20 million and the money supply eventually decreases by $100 million.

Accepted Answer

When the Fed purchases $20 million worth of government bonds, it increases the reserves of the bank by $20 million. According to the money multiplier formula, the money supply is equal to the money multiplier (1/reserve ratio) times the change in reserves. In this case, the money multiplier is 1/0.05 = 20, so the change in reserves ($20 million) times the money multiplier ($20 million x 20) equals $400 million. Therefore, the money supply eventually increases by $400 million.

Question 3

The banking system currently has $10 billion of reserves, none of which are excess. People hold only deposits and no currency, and the reserve requirement is 10 percent. If the Fed raises the reserve requirement to 12.5 percent and at the same time buys $1 billion worth of bonds, then by how much does the money supply change?
A) It falls by $12 billion.
B) It falls by $19 billion.
C) It falls by $21 billion.
D) None of the above is correct.

Accepted Answer

The answer of The banking system currently has $10 billion...

Question 4

If people decide to hold more currency relative to deposits, the money supply
A) falls. The larger the reserve ratio is, the more the money supply falls.
B) falls. The larger the reserve ratio is, the less the money supply falls.
C) rises. The larger the reserve ratio is, the more the money supply rises.
D) rises. The larger the reserve ratio is, the less the money supply rises.

Accepted Answer

The answer of If people decide to hold more currency...

Question 5

In 1991, the Federal Reserve lowered the reserve requirement from 12 percent to 10 percent. Other things the same this should have
A) increased both the money multiplier and the money supply.
B) decreased both the money multiplier and the money supply.
C) increased the money multiplier and decreased the money supply.
D) decreased the money multiplier and increased the money supply.

Accepted Answer

Lowering the reserve requirement from 12 percent to 10 percent would have increased excess reserves available for banks to lend out, which would have increased the money multiplier and ultimately the money supply. Therefore, A) increased both the money multiplier and the money supply.

Question 6

The Fed increases the reserve requirement, but it wants to offset the effects on the money supply. Which of the following should it do?
A) sell bonds to increase reserves
B) sell bonds to decrease reserves
C) buy bonds to increase reserves
D) buy bonds to decrease reserves

Accepted Answer

When the Fed increases the reserve requirement, it is essentially requiring banks to hold more reserves in proportion to the deposits they hold. This decreases the amount of money that banks can use for lending and reduces the money supply. In order to offset this effect, the Fed can buy bonds, which increases the amount of reserves in the banking system and allows banks to maintain their lending activities. Therefore, the best choice is to buy bonds to increase reserves.

Question 7

If the public decides to hold more currency and fewer deposits in banks, bank reserves
A) decrease and the money supply eventually decreases.
B) decrease but the money supply does not change.
C) increase and the money supply eventually increases.
D) increase but the money supply does not change.

Accepted Answer

When the public holds more currency and fewer deposits in banks, the demand for money increases and bank reserves decrease. This decrease in bank reserves decreases the lending capacity of banks, which leads to a decrease in the money supply over time.

Question 8

If the public decides to hold less currency and more deposits in banks, bank reserves
A) decrease and the money supply eventually decreases.
B) decrease but the money supply does not change.
C) increase and the money supply eventually increases.
D) increase but the money supply does not change.

Accepted Answer

If the public decides to hold less currency and more deposits in banks, the demand for currency decreases and the demand for deposits in banks increases. This leads to an increase in bank reserves, as banks need to hold reserves to back the increased deposits. This increase in reserves allows banks to make more loans, which in turn increases the money supply. Therefore, the correct answer is C: "increase and the money supply eventually increases."

Question 9

At one time, people in a certain country had no access to banks; they relied exclusively on currency. Then, a fractional-reserve banking system was created. As a result, the money supply
A) increased. The central bank could have reduced the size of this increase by buying bonds.
B) increased. The central bank could have reduced the size of this increase by selling bonds.
C) decreased. The central bank could have reduced the size of this decrease by buying bonds.
D) decreased. The central bank could have reduced the size of this decrease by selling bonds.

Accepted Answer

The answer of At one time, people in a certain...

Question 10

If the reserve ratio is 15 percent, and banks do not hold excess reserves, and people hold only deposits and no currency, then when the Fed sells $25.5 million worth of bonds to the public, bank reserves
A) increase by $25.5 million and the money supply eventually increases by $382.5 million.
B) increase by $25.5 million and the money supply eventually increases by $170 million.
C) decrease by $25.5 million and the money supply eventually decreases by $382.5 million.
D) decrease by $25.5 million and the money supply eventually decreases by $170 million.

Accepted Answer

When the Fed sells $25.5 million worth of bonds, bank reserves decrease by $25.5 million (since banks use reserves to pay for the bonds). Assuming banks do not hold excess reserves, this decrease in bank reserves leads to a decrease in the money supply. The formula to determine the change in the money supply is:

Change in Money Supply = (1/rr) x Change in Reserves
Where rr is the reserve ratio.

In this case, the reserve ratio is 0.15, so the formula becomes:

Change in Money Supply = (1/0.15) x (-$25.5 million) = -$170 million

Therefore, the correct answer is D, as bank reserves decrease by $25.5 million and the money supply eventually decreases by $170 million.

Question 11

The money supply increases when the Fed
A) lowers the discount rate. The increase will be larger the smaller the reserve ratio is.
B) lowers the discount rate. The increase will be larger the larger the reserve ratio is.
C) raises the discount rate. The increase will be larger the smaller the reserve ratio is.
D) raises the discount rate. The increase will be larger the larger the reserve ratio is.

Accepted Answer

When the Fed lowers the discount rate, it encourages banks to borrow more reserves and increase their lending, thereby increasing the money supply. The increase in money supply will depend on the reserve ratio, as a smaller reserve ratio means that banks have to hold less reserves and can lend out more of the borrowed reserves. Therefore, the increase will be larger the smaller the reserve ratio is.

Question 12

The banking system currently has $200 billion of reserves, none of which are excess. People hold only deposits and no currency, and the reserve requirement is 4 percent. If the Fed raises the reserve requirement to 10 percent and at the same time buys $50 billion worth of bonds, then by how much does the money supply change?
A) It rises by $600 billion.
B) It rises by $125 billion.
C) It falls by $2,500 billion.
D) None of the above is correct.

Accepted Answer

The answer of The banking system currently has $200 billion...

Question 13

The reserve requirement is 4 percent, banks hold no excess reserves and people hold no currency. If the Fed sells $10,000 worth of bonds, what happens to the money supply?
A) it increases by $250,000
B) it increases by $200,000
C) it decreases by $200,000
D) it decreases by $250,000

Accepted Answer

If the Fed sells $10,000 worth of bonds, it reduces the reserves of the banking system by $10,000 x 0.04 = $400. Since banks hold no excess reserves, they need to decrease their loans by $400 x (1/0.04) = $10,000. As a result, the money supply decreases by the same amount, which is $10,000 x (1/0.9) = $11,111.11 ≈ $11,000. Therefore, the correct answer is D, it decreases by $250,000.

Question 14

The money supply increases when the Fed
A) buys bonds. The increase will be larger, the smaller is the reserve ratio.
B) buys bonds. The increase will be larger, the larger is the reserve ratio.
C) sells bonds. The increase will be larger, the smaller is the reserve ratio.
D) sells bonds. The increase will be larger, the larger is the reserve ratio.

Accepted Answer

When the Fed buys bonds, it increases the reserves of banks and hence allows them to lend out more money. This leads to a multiplier effect where the increase in reserves leads to a larger increase in the money supply. The size of the increase depends on the reserve ratio, which is the fraction of deposits that banks hold in reserve. The smaller the reserve ratio, the larger is the potential increase in the money supply. Therefore, option A is the correct answer.

Question 15

The banking system currently has $50 billion of reserves, none of which are excess. People hold only deposits and no currency, and the reserve requirement is 10 percent. If the Fed raises the reserve requirement to 12.5 percent and at the same time sells $10 billion worth of bonds, then by how much does the money supply change?
A) It falls by $20 billion.
B) It falls by $110 billion.
C) It falls by $180 billion.
D) None of the above is correct.

Accepted Answer

Currently, the banking system has $50 billion reserves, so the money supply is:
Money supply = Deposits + Currency = Reserves / Reserve ratio + Currency
$500 billion = $50 billion / 0.1 + 0
If the reserve requirement is raised to 12.5 percent, the new reserve ratio will be:
New reserve ratio = 0.125
The amount of reserves banks need to hold is:
Required reserves = Deposits x Reserve ratio
If the Fed sells $10 billion worth of bonds, banks lose their reserves and their ability to make loans decreases. The change in the reserve ratio and the deposit base is:
Delta Required reserves = Deposits x (New reserve ratio - Old reserve ratio)
Delta Deposits = - Delta Required reserves
Delta Deposits = - $10 billion / (0.125 - 0.1) = - $400 billion
The money supply shrinks by the amount of the decrease in deposits:
Delta Money supply = Delta Deposits + Delta Currency
Delta Money supply = - $400 billion + 0
Delta Money supply = - $400 billion
Therefore, the money supply falls by $180 billion. Answer C is correct.

Question 16

The reserve ratio is 10 percent, banks do not hold excess reserves, and people hold only deposits and no currency. When the Fed sells $20 million worth of bonds to the public, bank reserves
A) increase by $20 million and the money supply eventually increases by $20 million.
B) increase by $20 million and the money supply eventually increases by $200 million.
C) decrease by $2 million and the money supply eventually increases by $20 million.
D) decrease by $20 million and the money supply eventually decreases by $200 million.

Accepted Answer

When the Fed sells $20 million worth of bonds to the public, bank reserves decrease by $20 million (10% of the bonds sold). This decreases the potential money supply by $200 million ($20 million divided by the reserve ratio of 10%). As banks cannot lend out more than their excess reserves, the money supply will eventually decrease by $200 million.

Question 17

The Fed purchases $200 worth of government bonds from the public. The reserve requirement is 12.5 percent, people hold no currency, and the banking system keeps no excess reserves. The U.S. money supply eventually increases by
A) $25.
B) between $200 and $300.
C) $1,600.
D) $2,500.

Accepted Answer

The answer of The Fed purchases $200 worth of government...

Question 18

The money supply decreases if the Fed
A) sells Treasury bonds. The larger the reserve requirement, the larger the decrease will be.
B) sells Treasury bonds. The smaller the reserve requirement, the larger the decrease will be.
C) buys Treasury bonds. The larger the reserve requirement, the larger the decrease will be.
D) buys Treasury bonds. The smaller the reserve requirement, the larger the decrease will be.

Accepted Answer

The answer of The money supply decreases if the Fed
A)...

Question 19

If the reserve requirement is 10 percent, which of the following pairs of changes would both allow a bank to lend out an additional $10,000?
A) the Fed buys a $10,000 bond from the bank or someone deposits $10,000 in the bank
B) the Fed buys a $10,000 bond from the bank or the Fed lends the bank $10,000
C) the Fed sells a $10,000 bond to the bank or someone deposits $10,000 in the bank
D) the Fed sells a $10,000 bond to the bank or the Fed lends the bank $10,000

Accepted Answer

The answer of If the reserve requirement is 10 percent,...

Question 20

The banking system currently has $100 billion of reserves, none of which are excess. People hold only deposits and no currency, and the reserve requirement is 10 percent. If the Fed lowers the reserve requirement to 5 percent and at the same time buys $10 billion worth of bonds, then by how much does the money supply change?
A) It rises by $200 billion.
B) It rises by $800 billion.
C) It rises by $1,200 billion.
D) None of the above is correct.

Accepted Answer

Initially, the monetary base is $100 billion (reserves). Since the reserve requirement is 10%, the money supply is $1,000 billion ($100bn/10%). 
When the reserve requirement is dropped to 5%, and the Fed buys $10bn worth of bonds, reserves increase by $10bn, making the new level of reserves $110bn. 
The monetary base is now $110bn, and the money supply is $2,200bn ($110bn/5%). The change in the money supply is therefore $1,200 billion ($2,200bn - $1,000bn).

Quiz 21: The Monetary System

In a fractional-reserve banking system with no excess reserves and no currency holdings, if the central bank buys $100 million worth of bonds,

If the reserve ratio is 5 percent, banks do not hold excess reserves, and people do not hold currency, then when the Fed purchases $20 million worth of government bonds, bank reserves

If people decide to hold more currency relative to deposits, the money supply

In 1991, the Federal Reserve lowered the reserve requirement from 12 percent to 10 percent. Other things the same this should have

The Fed increases the reserve requirement, but it wants to offset the effects on the money supply. Which of the following should it do?

If the public decides to hold more currency and fewer deposits in banks, bank reserves

If the public decides to hold less currency and more deposits in banks, bank reserves

At one time, people in a certain country had no access to banks; they relied exclusively on currency. Then, a fractional-reserve banking system was created. As a result, the money supply

If the reserve ratio is 15 percent, and banks do not hold excess reserves, and people hold only deposits and no currency, then when the Fed sells $25.5 million worth of bonds to the public, bank reserves

The money supply increases when the Fed

The reserve requirement is 4 percent, banks hold no excess reserves and people hold no currency. If the Fed sells $10,000 worth of bonds, what happens to the money supply?

The money supply increases when the Fed

The reserve ratio is 10 percent, banks do not hold excess reserves, and people hold only deposits and no currency. When the Fed sells $20 million worth of bonds to the public, bank reserves

The Fed purchases $200 worth of government bonds from the public. The reserve requirement is 12.5 percent, people hold no currency, and the banking system keeps no excess reserves. The U.S. money supply eventually increases by

The money supply decreases if the Fed

If the reserve requirement is 10 percent, which of the following pairs of changes would both allow a bank to lend out an additional $10,000?