Economics Chapter 16 Review Questions

Questions and Answers

The money supply in an economy equals:

Money multiplier multiplied by monetary base (correct)

Monetary base plus money multiplier

Money multiplier divided by monetary base

Monetary base divided by money multiplier

The main asset on the Federal Reserve's balance sheet is:

Discount loans

Monetary base

Securities (correct)

Capital

The main liability on the Federal Reserve's balance sheet is:

Securities

Capital

Discount loans

The monetary base (correct)

Currency held by the nonbank public plus banks' vault cash plus banks' deposits at the Fed equals:

The monetary base Signup and view all the answers

Green Bank has transaction accounts worth $200 million. If the required reserve ratio is 10%, how much does Green Bank hold as required reserves?:

$20 million Signup and view all the answers

Third Bank has reserves of $12.3 million and transaction accounts of $115 million. If required reserves are 10% of transaction accounts, how much excess reserves does Third Bank have?:

$0.8 million Signup and view all the answers

Consider a bank that has $10 million in reserves, $5 million in securities, and $100 million in transaction accounts. If a customer sells $2 million in securities to the Fed, how much do the bank's reserves increase to?:

Reserves increase to $12 million Signup and view all the answers

The money multiplier equals:

The money supply divided by the monetary base Signup and view all the answers

M1 money multiplier equals:

(Transaction accounts + currency) ÷ monetary base Signup and view all the answers

M2 money multiplier equals:

(M1 + nontransaction accounts + money market funds) ÷ monetary base Signup and view all the answers

If a bank in the economy has excess reserves of $3 million, and required reserves are 10% of transaction accounts, how much will the money supply eventually increase by?:

$30 million Signup and view all the answers

If the M2 multiplier is 8.3, how much would the Fed need to add to the monetary base in order to increase the M2 measure of the money supply by $830 million?:

$100 million Signup and view all the answers

If the M1 multiplier is 3 and the Fed engages in open-market sales in the amount of $3 billion, then M1 will:

Decline by $9 billion Signup and view all the answers

Another name for the monetary base is:

High-powered money Signup and view all the answers

An increase in interest rates:

Decreases the ratio of excess reserves to transaction accounts held by banks Signup and view all the answers

If the excess reserves held by banks increase, the money multiplier is likely to:

Fall Signup and view all the answers

If the M2 multiplier is currently 8 and people decide to increase the ratio of currency they hold relative to the amount of transactions accounts they hold, the M2 multiplier will:

Decrease Signup and view all the answers

Suppose the M1 multiplier is currently 1.95 and the M2 multiplier is currently 8.03. If the ratio of retail money-market mutual funds to transaction accounts increases, the M1 multiplier will _ and the M2 multiplier will _.

Not change; increase Signup and view all the answers

Suppose the M1 multiplier is currently 1.95 and the M2 multiplier is currently 8.03. If people decide to decrease the ratio of nontransaction accounts they hold relative to the amount of their transaction accounts, the M1 multiplier will and the M2 multiplier will:

Not change; decrease Signup and view all the answers

If the ratio of currency to transaction accounts is 2, the ratio of nontransaction accounts to transaction accounts is 5, the ratio of retail money-market funds to transaction accounts is 1, the ratio of required reserves to transaction accounts is 0.08, and the ratio of excess reserves to transaction accounts is 0.02, the M1 multiplier is about:

1.42 Signup and view all the answers

If the ratio of currency to transaction accounts is 2, the ratio of nontransaction accounts to transaction accounts is 5, the ratio of retail money-market funds to transaction accounts is 1, the ratio of required reserves to transaction accounts is 0.08, and the ratio of excess reserves to transaction accounts is 0.02, the M2 multiplier is about:

4.25 Signup and view all the answers

If the Open-Market Desk at the Fed sells securities, the most likely effect is that the:

Federal funds rate increases Signup and view all the answers

If the Open-Market Desk at the Fed buys securities, the most likely effect is that the:

Federal funds rate decreases Signup and view all the answers

During the holiday season in December, people use more currency than usual. To offset this increase in demand for money, the Fed increases the money supply through:

Defensive open-market operations Signup and view all the answers

The Fed undertakes defensive open-market operations:

Because of seasonal effects or to offset a temporary change in money demand Signup and view all the answers

If the Fed decides to tighten monetary policy, it uses to the money supply.

dynamic open-market operations; decrease Signup and view all the answers

The Fed undertakes dynamic open-market operations:

When it wants to change monetary policy Signup and view all the answers

The extra collateral the Fed requires above the value of a discount loan is known as:

A haircut Signup and view all the answers

If the haircut charged by the Fed is very large:

Banks will be discouraged from borrowing Signup and view all the answers

A bank in good condition may take out a loan without the Fed questioning the purpose or nature of the loan. Such a loan is known as:

A primary credit discount loan Signup and view all the answers

A bank in poor condition may take out a loan under close Fed scrutiny. Such a loan is known as:

A secondary credit discount loan Signup and view all the answers

A secondary credit discount loan has an interest rate that is __________ percentage point(s) higher than the interest rate on a primary credit discount loan:

1/2 Signup and view all the answers

A _______ is a loan from the Fed to a small agricultural bank.

Seasonal credit discount loan Signup and view all the answers

Before 2008, an increase in reserve requirements by the Fed would:

Decrease the money multiplier Signup and view all the answers

The amount of nonborrowed reserves equals:

The monetary base minus the sum of the amount of discount loans and currency Signup and view all the answers

Primary credit discount loans for profit will be zero when:

Primary credit discount rate is less than federal funds rate Signup and view all the answers

The supply curve of reserves in an economy is when the federal funds rate is less than the primary credit discount rate:

Vertical Signup and view all the answers

The supply curve of reserves in an economy is horizontal when:

The federal funds rate equals the primary credit discount rate Signup and view all the answers

An increase in the amount of discount loans by the Fed:

Increases the money supply by an amount equal to the increase in the loans times the multiplier Signup and view all the answers

The sum of seasonal credit discount loans, secondary credit discount loans, and primary credit discount loans that banks take out because of temporary problems are known as:

Discount loans that arise for business needs Signup and view all the answers

If the federal funds rate is below its target, the Fed is likely to securities in the open market, which will cause the federal funds rate to .

Sell; increase Signup and view all the answers

If the federal funds rate equals the primary credit discount rate, the Fed is likely to _____ securities in the open market, which will cause the federal funds rate to _.

Buy; decrease Signup and view all the answers

If the Open-Market Desk at the Fed buys securities when the federal funds rate is below the primary credit discount rate, the most likely effect is that the:

Federal funds rate decreases Signup and view all the answers

A __________ is a situation in which additions to an economy's monetary base do not lead to an increase in the economy's money supply or decline the interest rate.

Liquidity trap Signup and view all the answers

Which of the following is true of an economy in a liquidity trap?:

The economy's nominal short-term interest rates become close to zero Signup and view all the answers

Which of the following is true of an economy that has hit the zero lower bound?:

Any increase in its monetary base is exactly offset by a decline in its money multipliers Signup and view all the answers

Study Notes

Money Supply and Multiplier

Money supply in an economy is calculated as the money multiplier multiplied by the monetary base.
Money multiplier equals the money supply divided by the monetary base.

Federal Reserve's Balance Sheet

Main asset on the Federal Reserve's balance sheet: securities.
Main liability: the monetary base.
The monetary base comprises currency held by the public, banks' vault cash, and banks' deposits at the Fed.

Bank Reserves

Required reserves for Green Bank with $200 million in transaction accounts at a 10% reserve ratio is $20 million.
Third Bank with $12.3 million in reserves and $115 million in transaction accounts has $0.8 million in excess reserves, given a 10% reserve requirement.

Impact of Transactions

A bank with $10 million in reserves and $100 million in transaction accounts can increase its reserves to $12 million if it sells $2 million in securities to the Fed.

M1 and M2 Money Multipliers

M1 money multiplier formula: (transaction accounts + currency) ÷ monetary base.
M2 money multiplier formula: (M1 + nontransaction accounts + money market funds) ÷ monetary base.

Changes in Money Supply

An increase of $3 million in excess reserves can eventually raise the money supply by $30 million.
An M2 multiplier of 8.3 requires the Fed to add $100 million to increase the M2 money supply by $830 million.
If the M1 multiplier is 3 and the Fed sells $3 billion in securities, M1 will decline by $9 billion.

Open-Market Operations

Open-market sales by the Fed likely result in an increase in the federal funds rate.
Open-market purchases generally lead to a decrease in the federal funds rate.

Types of Open-Market Operations

Defensive open-market operations address seasonal effects or temporary changes in money demand.
Dynamic open-market operations are utilized to change monetary policy.

Discount Loans

The extra collateral required by the Fed for a discount loan is known as a haircut.
A primary credit discount loan permits banks in good standing to borrow without extensive inquiry.
Secondary credit discount loans are closely scrutinized and have a 1/2 percentage point higher interest rate than primary loans.

Monetary Base and Reserve Requirements

An increase in reserve requirements results in a decrease in the money multiplier.
Nonborrowed reserves equal the monetary base minus the sum of discount loans and currency.

Market Supply Curves

The supply curve of reserves is vertical when the federal funds rate is less than the primary credit discount rate.
The curve is horizontal if the federal funds rate equals the primary credit discount rate.

Economic Conditions

An increase in discount loans by the Fed directly increases the money supply.
A liquidity trap occurs when increases in monetary base do not result in a higher money supply or lower interest rates.

Zero Lower Bound

At the zero lower bound, increases in the monetary base do not yield increases in money supply, leading to a decline in money multipliers.

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Test your knowledge with these flashcards focusing on key concepts from Economics Chapter 16. The quiz covers essential topics including the money supply and the Federal Reserve's balance sheet. Perfect for students looking to reinforce their understanding of economic principles.