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Key Terms
Formulas
Money
Creation
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FED Tools
Because interest foregone is an opportunity
cost of holding money; as interest rates rise,
people decrease their money balances (and
vice versa). This inverse relationship
illustrates the:
Asset or Speculative Demand for Money
Transactions Demand for Money
Aggregate Demand Curve
Supply of Money
The transactions demand for money:
varies inversely with interest rates.
varies directly with interest rates
varies inversely inversely with the nominal GDP.
varies directly with the nominal GDP.
A single bank can create money by the
amount of its . . .
Actual reserves
Required reserves
Excess reserves
Deposits
Bond prices and interest rates . . .
vary directly
vary inversely
are independent of each other
increase or decrease together
M1, the most narrow measure of the money
supply, consists of:
Currency and checkable deposits
Currency, checkable deposits and small time deposits
Currency, checkable deposits and large time deposits
Paper money and coins only
In the equation of exchange (MV=PQ):
M = money supply
V = velocity of money (the number of times the dollar is spent)
PQ = nominal GDP
All of the above are correct
The maximum amount of new money the
banking system can create from a deposit is
equal to:
1 / reserve requirement
Actual reserves – required reserves
The deposit multiplier x the initial excess reserves
The money supply x the velocity of money
The amount of new money a single bank can
create is equal to:
1/reserve requirement
Its excess reserves
Excess reserves x the deposit multiplier
Existing deposit + New money created by banking system
If the reserve requirement is 5%, the deposit
multiplier is:
5
5 x the excess reserves
20
25
Excess reserves =
1 / reserve requirement
Deposit multiplier x the actual reserves
Reserve requirement x deposits
Actual reserves – required reserves
Assume the FED purchases a $1000 bond and
the payment for the bond is deposited in bank
A. If the reserve requirement is 10%, what is
the maximum change in the money supply
that could result from the bond purchase?
$100
$900
$9,000
$10,000
If you deposit $1500 in pocket change into
your checking account at the bank, the
immediate result is:
The money supply increases by $1500
The money supply decreases by $1500
The money supply does not change, but its composition
changes from $1500 currency to $1500 demand deposits.
The money supply increases by $1500 and its composition
changes from $1500 in cash to $1500 in checkable deposits.
If the reserve requirement is 20%, the bank
must keep how much of a $1000 deposit in
the bank vault or on deposit at the FED?
$1000
$200
$800
$4000
Assume the FED sells $20,000 in bonds to a
bank customer. If the reserve requirement is
20% and the customer pays for the bonds by
check, the maximum change in the money
supply that could result from the bond sale is:
$4000 decrease
$16,000 increase
$80,000 increase
$100,000 decrease
If the reserve requirement is 25%, the deposit
multiplier is:
25
5
4
2.5
If the economy is in a severe recession, which
of the following would be an appropriate
monetary policy action?
FED purchase of bonds on the open market
Increase the discount rate
Increase the reserve requirement
FED sale of bonds on the open market
An open market operation:
Occurs when the FED makes a loan to a bank and charges the
Discount rate.
Involves the FED in the buying or selling of government
Securities.
Increases or decreases the % of deposits a bank must keep
In the vault or on deposit at the FED.
Is the least used tool of monetary policy
Which one of the following would be a
contractionary monetary policy action to fight
inflation?
FED purchase of bonds
Decrease the discount rate
Increase the reserve requirement
Increase taxes
In a severe recession, the FED might use
which of the following tools?
Lower the reserve requirement to allow banks to increase their
loans.
Lower the discount rate to make it easier for banks to borrow
from the FED.
Purchased bonds on the open market to increase bank reserves
and put downward pressure on interest rates.
All of the above tools are expansionary monetary policy tools
available to the FED.
All of the following are tight money policy
actions EXCEPT:
FED sale of bonds on the open market
Raising the reserve requirement
Raising the discount rate
Raising taxes
Bond prices and interest rates
Are unrelated
Vary directly
Vary inversely
Move in the same direction
Assume a reserve requirement of 20%. If
excess reserves are $10,000, what is the
maximum amount of new money the banking
system can create?
$50,000
$2000
$8000
$40,000
If the reserve requirement is 10% and deposits
are 100,000, excess reserves are:
$10,000
$90,000
$900,000
10
If nominal GDP is 5 trillion and the velocity
of money is 5, the money supply needed to
purchase the GDP is:
$5 trillion
$1 trillion
$25 trillion
None of the above
Assume a bank currently has $20,000 in
excess reserves. If a deposit of $10,000 is
made, what is the maximum the bank could
loan out if the reserve requirement were 10%?
$20,000
$27,000
$29,000
$200,000
Assume the economy is experiencing
inflation. Which one of the following FED
tools could be employed to put a damper on
prices?
a. Increase the reserve requirement
b. Increase the discount rate
c. FED purchase of bonds on the open market
a and b only
The discount rate is:
The interest rate banks charge each other for temporary loans.
The interest rate the FED charges banks for loans.
The percent of deposits a bank must keep in the vault or on
deposit at the FED.
None of the above.
If the economy is experiencing severe
inflation, which of the following would be an
appropriate monetary policy action?
Purchase bonds on the open market
Sell bonds on the open market
Lower the discount rate
Lower the reserve requirement