Macro Tut 5: The Monetary System

Multiple Choice: Identify the choice that best completes the statement or answers the question.

1. Consider the following traders who meet.

Bob has an apple wants an orange

Ted has an orange wants a peach
Mary has a pear wants an apple
Alice has a peach wants an orange

Which, if any, pairs of traders has a double coincidence of wants?

a. Bob with Alice
b. Ted with Alice
c. Bob with Mary, Ted with Bob, and Ted with Alice
d. None of the pairs above has a double coincidence of wants.
2. Money is
a. the most liquid asset and a perfect store of value.
b. the most liquid asset but an imperfect store of value.
c. the least liquid asset but a perfect store of value.
d. the least liquid asset and an imperfect store of value.
3. Which of the following best illustrates the concept of a store of value?
a. You are a precious-metals dealer, and you are always aware of how many ounces of platinum
trade for an ounce of gold.
b. You sell items on eBay, and your prices are stated in terms of dollars.
c. You keep 6 ounces of gold in your safe-deposit box at the bank for emergencies.
d. None of the above is correct.

4. Travelers checks are included in

a. M1 but not M2.
b. M2 but not M1.
c. M1 and M2.
d. neither M1 nor M2.

5. Savings deposits are included in

a. M1 but not M2.
b. M2 but not M1.
c. M1 and M2.
d. neither M1 nor M2.

6. At the Federal Reserve,

a. the nation’s monetary policy is made by the Federal Open Market Committee, which meets twice a year.
b. the nation’s monetary and fiscal policies are made by the Federal Open Market Committee, which meets
twice a year.
c. the nation’s monetary policy is made by the Federal Open Market Committee, which meets about every
six weeks.
d. the nation’s monetary and fiscal policies are made by the Federal Open Market Committee, which meets
about every six weeks.

7. When the Federal Reserve sells assets from its portfolio to the public with the intent of changing the
money supply,
a. those assets are government bonds and the Fed’s reason for selling them is to increase the money
supply.
b. those assets are government bonds and the Fed’s reason for selling them is to decrease the money
supply.
c. those assets are items that are included in M2 and the Fed’s reason for selling them is to increase
the money supply.
d. those assets are items that are included in M2 and the Fed’s reason for selling them is to decrease
the money supply.

8. Which of the following entities actually executes open-market operations?

a. the Board of Governors
b. the New York Federal Reserve Bank
c. the Federal Open Market Committee
d. the Open Market Committees of the regional Federal Reserve Banks

Table 29-2. An economy starts with $10,000 in currency. All of this currency is deposited into a single bank,
and the bank then makes loans totaling $9,250. The T-account of the bank is shown below.

Assets Liabilities
Reserves $750 Deposits $10,000
Loans 9,250

9. Refer to Table 29-2. If all banks in the economy have the same reserve ratio as this bank, then an
increase in reserves of $150 for this bank has the potential to increase deposits for all banks by
a. $866.67.
b. $1,666.67.
c. $2,000.00.
d. an infinite amount.

Table 29-3.

The First Bank of Johnson City

Assets Liabilities
Reserves $2,000 Deposits $10,000
Loans 8,000

10. Refer to Table 29-3. If $1,000 is deposited into the First Bank of Johnson City, and the bank takes no
other actions, its
a. reserves will increase by $200.
b. liabilities will decrease by $1,000.
c. assets will increase by $1,000.
d. reserves will increase by $800.

Table 29-4.

The First Bank of Wahooton

Assets Liabilities
Reserves $25,000 Deposits $150,000
Loans 125,000

11. Refer to Table 29-4. Suppose the bank faces a reserve requirement of 10 percent. Starting from the
situation as depicted by the T-account, a customer deposits an additional $50,000 into his account at the
bank. If the bank takes no other action it will
a. have $65,000 in excess reserves.
b. have $55,000 in excess reserves.
c. need to raise an additional $5,000 of reserves to meet the reserve requirement
d. None of the above is correct.
Table 29-6.
Bank of Springfield

Assets Liabilities
Reserves $19,200 Deposits $240,000
Loans 228,000

12. Refer to Table 29-6. If the Bank of Springfield has lent out all the money it can given its level of
deposits, then what is the reserve requirement?
a. 5.00 percent
b. 8.00 percent
c. 8.42 percent
d. 95.00 percent

13. If $300 of new reserves generates $800 of new money in the economy, then the reserve ratio is
a. 2.7 percent.
b. 12.5 percent.
c. 37.5 percent.
d. 40 percent.

14. When the Fed buys government bonds,

a. the money supply increases and the federal funds rate increases.
b. the money supply increases and the federal funds rate decreases.
c. the money supply decreases and the federal funds rate increases.
d. the money supply decreases and the federal funds rate decreases.

15. A bank’s liabilities include

a. both its reserves and the deposits of its customers.
b. neither its reserves nor the deposits of its customers.
c. its reserves, but not the deposits of its customers.
d. the deposits of its customers, but not its reserves.

16. In Hugoland, the money supply is $8 million and reserves are $1 million. Assuming that people hold
only deposits and no currency, and that banks hold no excess reserves, then the reserve requirement is
a. 14 percent.
b. 12.5 percent.
c. 8 percent.
d. None of the above is correct.

Scenario 29-1.
The monetary policy of Salidiva is determined by the Salidivian Central Bank. The local currency is the salido.
Salidivian banks collectively hold 100 million salidos of required reserves, 25 million salidos of excess reserves,
250 million salidos of Salidivian Treasury Bonds, and their customers hold 1,000 million salidos of deposits.
Salidivians prefer to use only demand deposits and so the money supply consists of demand deposits.
17. Refer to Scenario 29-1. Suppose the Central Bank of Salidiva loaned the banks of Salidiva 5 million
salidos. Suppose also that both the reserve requirement and the percentage of deposits held as excess
reserves stay the same. By how much would the money supply of Salidiva change?
a. 60 million salidos
b. 50 million salidos
c. 40 million salidos
d. None of the above is correct.

18. 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 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.

19. During a bank run, depositors decide to hold more currency relative to deposits and banks decide to
hold more excess reserves relative to deposits.
a. Both the decision to hold relatively more currency and the decision to hold relatively more excess
reserves would make the money supply increase.
b. Both the decision to hold relatively more currency and the decision to hold relatively more excess
reserves would make the money supply decrease.
c. The decision to hold relatively more currency would make the money supply increase. The
decision to hold relatively more excess reserves would make the money supply decrease.
d. The decision to hold relatively more currency would make the money supply increase. The
decision to hold relatively more excess reserves would make the money supply decrease.

20. When the Fed conducts open-market purchases,

a. it buys Treasury securities, which increases the money supply.
b. it buys Treasury securities, which decreases the money supply.
c. it borrows money from member banks, which increases the money supply.
d. it lends money to member banks, which decreases the money supply.

EXERCISES AND PROBLEMS

Exercise 1: Fill in the blank with NO MORE THAN 4 WORDS

1. Money serves as a …………………because money is the most commonly accepted asset when a
buyer purchases goods and services from a seller.

2. Money serves as a ………………….because money is the yardstick with which people post
prices and record debts.

3. Money serves as a …………………..because people can use money to transfer purchasing power
from the present to the future.
4. Money can be divided into two fundamental types-…………. And……………..

5. Fiat money is money without…………….

6. ……………..is the amount of money the banking system generates from each dollar of reserves
7. …………….. is a banking system in which banks hold only a fraction of deposits as reserves

8. ………………is the balances in bank accounts that can be accessed on demand by check

9. The Fed primarily changes the money supply with…………………, which are the purchase and
sale of U.S. government bonds by the Fed in the open market for debt
10. ………………. Is the interest rate the Fed charges on loans to banks

Excercise 2: Find the underlined parts that are incorrect in these statements and correct them:
11. Money has three functions: It acts as a medium of exchange, a unit of account, and a
A B C
hedge against inflation.
D
12. Credit cards are part of the M2 money supply and are valued at the maximum credit
A B C
limit of the cardholder.
13. An increase in the reserve requirement decreases the money multiplier and increases
A B C
the money supply.
D
14. When you are willing to go to sleep tonight with $100 in your wallet and you have complete
confidence that you can spend it tomorrow and receive the same amount of
A
goods as you would have received had you spent it today, money has demonstrated its
B
function as a medium of exchange.
C
15. Money and wealth are the same thing
 A B C
Problem 1:
Assume that the banking system has total reserves of $100 billion. Assume also that required reserves are 10
percent of checking deposits and that banks hold no excess reserves and households hold no currency.

a. a. What is the money multiplier? What is the money supply?

b. b. If the Fed now raises required reserves to 20 percent of deposits, what are the changes in reserves
and in the money supply?

Problem 2:

Assume that the reserve requirement is 20 percent. Also assume that banks do not hold excess reserves and there
is no cash held by the public. The Federal Reserve decides that it wants to expand the money supply by $40
million dollars.

a. a. If the Fed is using open-market operations, will it buy or sell bonds?

b. b. What quantity of bonds does the Fed need to buy or sell to accomplish the goal? Explain your
reasoning.

Problem 3:

Suppose that First National Bank acquires $600,000 in new deposits and initially uses part of this to make new
loans of $400,000. The T-account of First National Bank, showing changes in its assets and liabilities, is as
follows:

a) Suppose that the Fed requires banks to hold 10 percent of deposits as reserves, and that prior to the changes
shown above the First National Bank was satisfying that requirement exactly. How much in excess reserves does
First National now hold, as a result of the changes listed above?

b) Assume that all other banks hold only the required amount of reserves and that the public holds no cash. If First
National now decides to reduce its reserves to only the required amount, by how much will the economy’s money
supply increase?