Monetary System Overview

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Questions and Answers

What are demand deposits primarily recognized as?

Investments in money market funds

Funds held in checking accounts (correct)

Physical currency only

Funds held in savings accounts

What distinguishes bitcoins from commodity money?

Bitcoins have no intrinsic value. (correct)

Bitcoins have intrinsic value.

Bitcoins can be used for multiple purposes beyond exchange.

Bitcoins are created by government decree.

Which function of money is currently least fulfilled by bitcoin?

Medium of exchange

Unit of account (correct)

All three functions are equally fulfilled

Store of value

What aspect of bitcoins do some users find appealing?

Anonymity in transactions Signup and view all the answers

Which of the following statements about the price of bitcoin is true?

Bitcoin prices have fluctuated wildly. Signup and view all the answers

What is the role of a central bank in a fiat money system?

Controlling the supply of money through monetary policy. Signup and view all the answers

Which characteristic of bitcoin makes it a risky way to hold wealth?

High day-to-day price volatility. Signup and view all the answers

Which of the following is a reason some economists are skeptical about bitcoin's future?

Its poor performance in traditional money functions. Signup and view all the answers

What is monetary policy primarily concerned with?

Control of the money supply. Signup and view all the answers

What percentage of the initial deposit does the bank keep in reserve?

20% Signup and view all the answers

How much money is eventually created from an original deposit of $1,000 when the reserve-deposit ratio is 0.2?

$5,000 Signup and view all the answers

What is the process called that transfers resources from savers to borrowers?

Financial Intermediation Signup and view all the answers

Which of the following financial institutions has the legal authority to create assets that are part of the money supply?

Banks Signup and view all the answers

What does money creation by the banking system primarily increase in the economy?

Liquidity Signup and view all the answers

In the scenario provided, what is the total amount of loans made by Thirdbank?

$512 Signup and view all the answers

Which statement accurately describes the difference between banks and other financial institutions?

Banks are the only institutions that can create money. Signup and view all the answers

What is the main outcome of fractional-reserve banking as mentioned in the content?

It increases the economy's liquidity without creating real wealth. Signup and view all the answers

What is the primary function of money in a modern economy?

To facilitate trade among multiple parties Signup and view all the answers

What distinguishes fiat money from commodity money?

Fiat money is accepted by government decree, unlike commodity money Signup and view all the answers

Which of the following is an example of commodity money?

Cigarettes in a POW camp Signup and view all the answers

What economic situation led to the use of cigarettes as currency in POW camps?

Inefficiency of ration allocation and the need for trade Signup and view all the answers

In the context of the POW camp economy, what does 'double coincidence of wants' refer to?

Both parties must want the items being exchanged Signup and view all the answers

During which time period was the gold standard most common throughout the world?

Late nineteenth century Signup and view all the answers

What essential characteristic does fiat money lack compared to commodity money?

Value in industry and trade Signup and view all the answers

How does the structure of transactions in modern economies mainly differ from barter systems?

Modern economies use a universal medium of exchange Signup and view all the answers

What happens to a bank's capital if its assets decrease in value by more than 5 percent?

The bank becomes insolvent. Signup and view all the answers

Why do regulators require banks to hold sufficient capital?

To ensure the bank can pay off its depositors and creditors. Signup and view all the answers

How does the type of assets a bank holds affect its capital requirements?

Riskier assets require more capital. Signup and view all the answers

What consequence can arise from a fear of bank capital running out?

Bank runs may occur. Signup and view all the answers

What was a significant impact of the financial crisis of 2008–2009 on banks?

Many banks became insolvent due to large losses. Signup and view all the answers

What effect does a dollar added to the economy by the Federal Reserve have if held as currency?

It increases the money supply by exactly one dollar. Signup and view all the answers

How do losses to bank capital compare to losses to bank assets due to leverage?

Losses to bank capital are proportionately larger than losses to bank assets. Signup and view all the answers

What is the significance of the leverage ratio in banking?

It describes the proportion of assets that can be financed with equity. Signup and view all the answers

What effect does an increase in the interest rate on reserves have on the reserve–deposit ratio?

It increases the reserve–deposit ratio. Signup and view all the answers

Which policy involves the Federal Reserve buying long-term government bonds?

Quantitative easing Signup and view all the answers

During which years did the monetary base experience a significant increase approximately five-fold?

2007 to 2014 Signup and view all the answers

What was one of the initial steps taken by the Fed during the financial crisis?

Buying large quantities of mortgage-backed securities Signup and view all the answers

What was a major consequence of the substantial expansion in the monetary base from 2007 to 2014?

There was a large decline in the money multiplier. Signup and view all the answers

What is the primary function of the Federal Reserve as a lender of last resort during financial crises?

To lend money to banks in distress. Signup and view all the answers

What is an expected behavior of banks when the interest rate on reserves is increased?

They will choose to hold more reserves. Signup and view all the answers

What term describes the phenomenon where the monetary base increased significantly without a comparable increase in M1 and M2?

Disparity in money supply Signup and view all the answers

Study Notes

Monetary System

Macroeconomic policy has two main branches: monetary and fiscal policy
Fiscal policy involves government decisions on spending and taxes
Monetary policy concerns the nation's system of money, currency, and banking
Monetary policy is usually implemented by central banks which operate independently, such as the Federal Reserve in the U.S.

What is Money?

Money is a specific type of wealth, used for transactions
Money performs three key functions:
- Store of value: Transferring purchasing power from the present to the future
- Unit of account: Terms used for quoting prices and recording debts
- Medium of exchange: Used to buy goods and services
Fiat money has no intrinsic value, established by government decree, commonly used today
Commodity money has intrinsic value, such as gold

Types of Money

Fiat money lacks intrinsic value but is widely accepted as a means of exchange
Commodity money has inherent worth, often used as an early stage of currency

Money in a POW Camp

Barter, the exchange of goods or services directly, was inefficient
Cigarettes became a readily usable form of currency, store of value, and medium of exchange in a POW camp scenario

Development of Fiat Money

Commodity money (gold) is valuable because of its intrinsic worth
Transaction costs are higher when people use commodity money
Governments create gold coins to facilitate transactions, reducing transaction costs
Gold certificates (paper) are introduced, increasing transaction efficiency
Fiat money (paper) is eventually accepted by people as store of value and medium of exchange, dispensing the need for gold

The Role of Banks

100% Reserve Banking: Banks keep all deposited funds in reserve for withdrawal
Fractional Reserve Banking: Banks lend out a portion of deposited funds, increasing the money supply
Leverage: Banks use borrowed money to make investments in excess of their own capital
Capital requirements: Regulators set the minimum amount of capital a bank must hold, related to the types of assets that bank holds.

How the Quantity of Money is Measured

Measured as currency (cash) and demand deposits (checking account balances)
Other assets that are easily convertible to currency (e.g., deposits in savings accounts and money market funds) can be included, depending on the definition of the money supply

How Central Banks Influence the Money Supply

The monetary base is the sum of currency in circulation and bank reserves (directly controlled by the Federal Reserve)
Reserve-deposit ratio (rr): Fraction of deposits banks hold in reserve
Currency-deposit ratio (cr): Fraction of money people hold as currency
Money multiplier (m): Effect of monetary base on money supply (m = (cr + 1)/(cr + rr)
Open market operations: Buying or selling government bonds to increase or decrease the monetary base, influencing money supply

Instruments of Monetary Policy

Open market operations: Fed buys/sells government bonds, influencing the monetary base
Reserve requirements: Minimum fraction of deposits that banks must hold in reserve, impacting the money multiplier
Discount rate: Interest rate the Fed charges banks for borrowing reserves, influencing borrowing behavior

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Description

This quiz covers the fundamentals of the monetary system, including the roles of monetary and fiscal policy. Understand the different types of money, such as fiat and commodity money, and their functions in the economy. Test your knowledge on how central banks operate and the significance of money in transactions.