Podcast
Questions and Answers
Which statement regarding the Federal Reserve's structure and function is incorrect?
Which statement regarding the Federal Reserve's structure and function is incorrect?
- The Federal Reserve provides loans to banks.
- The U.S. Constitution established the Federal Reserve. (correct)
- The Federal Reserve regulates the banking system.
- The Federal Reserve can hold government bonds.
To stimulate economic activity, the Federal Reserve decides to increase the money supply. Which of the following actions would be most effective?
To stimulate economic activity, the Federal Reserve decides to increase the money supply. Which of the following actions would be most effective?
- Buying bonds in the open market. (correct)
- Increasing income tax rates.
- Decreasing income tax rates.
- Selling bonds in the open market.
Suppose a customer deposits currency into their checking account. Initially, the bank adds the entire deposit to its reserves. What is the immediate impact on the money supply, and how does this change if the bank subsequently lends out a portion of these reserves?
Suppose a customer deposits currency into their checking account. Initially, the bank adds the entire deposit to its reserves. What is the immediate impact on the money supply, and how does this change if the bank subsequently lends out a portion of these reserves?
- Money supply decreases; decreases less.
- Money supply increases; increases by less.
- Money supply increases; increases even more.
- Money supply is unchanged; increases. (correct)
If the central bank increases bank reserves by $120 and the reserve ratio is 25%, what is the maximum potential increase in the money supply?
If the central bank increases bank reserves by $120 and the reserve ratio is 25%, what is the maximum potential increase in the money supply?
Which action by the Federal Reserve would most likely lead to an increase in the money supply?
Which action by the Federal Reserve would most likely lead to an increase in the money supply?
How does an increase in the interest rate paid on reserves by the Fed typically impact the money supply?
How does an increase in the interest rate paid on reserves by the Fed typically impact the money supply?
In a fractional-reserve banking system, what happens to the money supply if individuals and banks simultaneously increase their holdings of currency and reserves, respectively, without any central bank intervention?
In a fractional-reserve banking system, what happens to the money supply if individuals and banks simultaneously increase their holdings of currency and reserves, respectively, without any central bank intervention?
What differentiates commodity money from fiat money?
What differentiates commodity money from fiat money?
Why are demand deposits included when calculating the money supply?
Why are demand deposits included when calculating the money supply?
Which entity is primarily responsible for setting monetary policy in the United States?
Which entity is primarily responsible for setting monetary policy in the United States?
How does the Federal Reserve typically execute an open-market operation to increase the money supply?
How does the Federal Reserve typically execute an open-market operation to increase the money supply?
Why do banks not maintain 100-percent reserves?
Why do banks not maintain 100-percent reserves?
What happens to the money supply when the Federal Reserve increases the discount rate?
What happens to the money supply when the Federal Reserve increases the discount rate?
What is the likely effect on the money supply when the Federal Reserve raises reserve requirements?
What is the likely effect on the money supply when the Federal Reserve raises reserve requirements?
Which scenario explains why the Fed cannot perfectly control the money supply?
Which scenario explains why the Fed cannot perfectly control the money supply?
Beleaguered State Bank (BSB) holds $250 million in deposits and maintains a reserve ratio of 10 percent. How much does BSB hold in loans?
Beleaguered State Bank (BSB) holds $250 million in deposits and maintains a reserve ratio of 10 percent. How much does BSB hold in loans?
Suppose that Daddy Warbucks withdraws $10 million in cash from Beleaguered State Bank (BSB), which initially held $250 million in deposits and had a reserve ratio of 10 percent. After the withdrawal, BSB decides to restore its reserve ratio by reducing the amount of loans outstanding. How much does the BSB hold in loans after daddy warbucks withdraws his cash?
Suppose that Daddy Warbucks withdraws $10 million in cash from Beleaguered State Bank (BSB), which initially held $250 million in deposits and had a reserve ratio of 10 percent. After the withdrawal, BSB decides to restore its reserve ratio by reducing the amount of loans outstanding. How much does the BSB hold in loans after daddy warbucks withdraws his cash?
Suppose that Daddy Warbucks withdraws $10 million in cash from Beleaguered State Bank (BSB), which initially held $250 million in deposits and had a reserve ratio of 10 percent. After the withdrawal, BSB decides to restore its reserve ratio by reducing the amount of loans outstanding. What problem could this cause for other banks?
Suppose that Daddy Warbucks withdraws $10 million in cash from Beleaguered State Bank (BSB), which initially held $250 million in deposits and had a reserve ratio of 10 percent. After the withdrawal, BSB decides to restore its reserve ratio by reducing the amount of loans outstanding. What problem could this cause for other banks?
What is the most practical reason for finding it difficult for the BSB to the action of restoring it's reserve ratio by calling in loans?
What is the most practical reason for finding it difficult for the BSB to the action of restoring it's reserve ratio by calling in loans?
If the Federal Reserve sells $1 million of government bonds, what is the overall effect on the economy’s total reserves and the money supply, given a reserve requirement for checking deposits is 10 percent and that banks do not hold any excess reserves?
If the Federal Reserve sells $1 million of government bonds, what is the overall effect on the economy’s total reserves and the money supply, given a reserve requirement for checking deposits is 10 percent and that banks do not hold any excess reserves?
Flashcards
What is commodity money?
What is commodity money?
Money with intrinsic value, also used as a commodity.
What is fiat money?
What is fiat money?
Money without intrinsic value, used as a medium of exchange by government decree.
What are demand deposits?
What are demand deposits?
Balances in bank accounts that depositors can access on demand by writing a check or using a debit card
Who is the FOMC?
Who is the FOMC?
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How does the Fed increase the money supply?
How does the Fed increase the money supply?
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Why don't banks hold 100% reserves?
Why don't banks hold 100% reserves?
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What is the discount rate?
What is the discount rate?
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What are reserve requirements?
What are reserve requirements?
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Why the Fed can't control the money supply perfectly?
Why the Fed can't control the money supply perfectly?
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How can a bank restore its reserve ratio?
How can a bank restore its reserve ratio?
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What happens if the Fed sells $1 million of government bonds?
What happens if the Fed sells $1 million of government bonds?
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Study Notes
- The Federal Reserve was not established by the U.S. Constitution.
- To increase the money supply, the Federal Reserve can buy bonds in open-market operations.
- If a bank adds the entire $100 deposit to reserves, the money supply remains unchanged, but if the bank lends out some of the $100, the money supply increases.
- With a reserve ratio of 1/4, if the central bank increases reserves by $120, the money supply increases by $480.
- A decrease in reserve requirements by the Fed would tend to increase the money supply.
- If the Fed raises the interest rate it pays on reserves, it will decrease the money supply by increasing excess reserves.
- In a fractional-reserve banking system, the money supply declines if households hold more currency or if banks hold more reserves.
- Commodity money has intrinsic value and can be used as a medium of exchange, like gold.
- Fiat money has no intrinsic value, and this type is currently used.
- Demand deposits are balances in bank accounts accessible on demand via checks or debit cards.
- Demand deposits should be included in the money supply due to their use as a medium of exchange.
- The Federal Open Market Committee (FOMC) sets monetary policy.
- The FOMC has 12 members, with 7 from the Federal Reserve Board of Governors and 5 of 12 presidents of Federal Reserve Banks (one being from NY).
- Board of Governors members are nominated by the U.S. President, confirmed by the Senate, and serve 14-year terms.
- Federal Reserve Bank presidents are selected by their respective bank's board and approved by the Board of Governors.
- To increase the money supply through open-market operations, the Federal Reserve purchases U.S. government bonds from the public, increasing the number of dollars in circulation.
- Banks do not hold 100% reserves because it is more profitable to make loans and earn interest.
- The less banks hold in reserve, the more the total money supply grows.
- The discount rate is the interest rate on loans that the Federal Reserve makes to banks.
- If the Fed increases the discount rate, banks borrow less, reserves lower, and the money supply decreases.
- Reserve requirements are regulations on the minimum amount of reserves that banks must hold against deposits.
- Increasing reserve requirements raises the reserve ratio, lowers the money multiplier, and decreases the money supply.
- The Fed cannot perfectly control the money supply because it cannot control the amount of money households choose to hold/deposit or the amount bankers choose to lend.
- Beleaguered State Bank (BSB) with $250 million in deposits and a 10% reserve ratio has $25 million in reserves and $225 million in loans.
- If a depositor withdraws $10 million and BSB restores its reserve ratio by reducing loans, it will have $24 million in reserves, $240 million in deposits, and $216 million in loans.
- BSB's action may cause other banks to cut back their loans to compensate being short on reserves.
- BSB may find it difficult to reduce loans immediately because they cannot force people to pay them off, but they can stop making new loans or alternatively attract additional deposits or borrow from other banks or the Fed to get additional reserves.
- If the reserve requirement is 10% and the Fed sells $1 million in government bonds, reserves decrease by $1 million, contracting the money supply by $10 million (money multiplier = 10).
- If the Fed lowers the reserve requirement to 5% but banks hold another 5% as excess reserves, the new money multiplier is 20.
- Banks might hold excess reserves for risk management.
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