Essentials of Economics Study Set 12

Business

Quiz 21 :

The Monetary System

Quiz 21 :

The Monetary System

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If the Fed wants to increase the money supply with open-market operations, what does it do?
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If the Fed wants to increase the supply of money with open-market operations, it would purchase government bonds from the public in the open market. It is just like creating money from thin air. The purchase increases the number of dollars in the hands of the public, thus raising the money supply of the economy.

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Happy Bank starts with $200 in bank capital. It then takes in $800 in deposits. It keeps 12.5 percent (1/8th) of deposits in reserve. It uses the rest of its assets to make bank loans. a. Show the balance sheet of Happy Bank. b. What is Happy Bank's leverage ratio? c. Suppose that 10 percent of the borrowers from Happy Bank default and these bank loans become worthless. Show the bank's new balance sheet. d. By what percentage do the bank's total assets decline? By what percentage does the bank's capital decline? Which change is larger? Why?
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It is given that the capital of the bank is $200 and it then take deposits worth $800. The reserve ratio is 12.5%. The rest of the deposits are used to make loans. First, calculate the amount of reserves the bank hold and the amount of money the bank lends as loans.
Calculation of reserves is as follow:
img Thus, the amount of money that must be kept as reserves are $100.
The loan given by the bank is equal to $700 ($800-$100)
(a)
The Balance sheet of bank-H is as follows:
img (b)
The leverage ratio is the ratio of the Banks's total assets to bank capital. Calculation of leverage ratio is shown below:
img Thus, the leverage ratio is 5.
(c)
Suppose that 10% of the borrowers from bank-H default and these bank loans become worthless. It means $90 (10% of $900) is worthless now and all the loss is capital loss and must be deducted from capital of the owner.
img (d)
It is seen from the balance sheets that before the default, the total assets of the bank are $1,000 and after the default the total asset of the bank is $910. The percentage change in total assets is shown below:
img Thus, the bank's total assets decreased by 9%. (negative sign denotes decrease)
It is seen from the balance sheets that before the default, the capital of the owner is 200 and after the default the capital of the owner is $110. The percentage change in capitals is shown below:
img Thus, the capital of the owner decreased by 45%. (negative sign denotes decrease)
The change is larger in bank capital as compared to change in bank's total assets because the bank mostly using other people's money as the deposits to make loans.

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The Fed conducts a $10 million open-market purchase of government bonds. If the required reserve ratio is 10 percent, what is the largest possible increase in the money supply that could result? Explain. What is the smallest possible increase? Explain.
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If the required reserve ratio is 10%, the money multiplier could be increase as
img = 10, if banks hold no excess reserves and people do not keep some additional currency. The additional currency is the excess amount.
The maximum increase in the money supply from a $10 million open-market purchase is $100 million ($10 Million × 10). Money supply will be acceptable.
The smallest possible increase is $10 million if all of the money is held by banks as additional reserves. Increase in ratio will be kept as additional currency.

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Why don't banks hold 100 percent reserves? How is the amount of reserves banks hold related to the amount of money the banking system creates?
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What are demand deposits and why should they be included in the stock of money?
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Which of the following are considered money in the U.S. economy? Which are not? Explain your answers by discussing each of the three functions of money. a. a U.S. penny b. a Mexican peso c. a Picasso painting d. a plastic credit card
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The money supply includes all of the following EXCEPT
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You take $100 you had kept under your mattress and deposit it in your bank account. If this $100 stays in the banking system as reserves and if banks hold reserves equal to 10 percent of deposits, by how much does the total amount of deposits in the banking system increase? By how much does the money supply increase?
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In a system of fractional-reserve banking, even without any action by the central bank, the money supply declines if households choose to hold _________ currency or if banks choose to hold _________ excess reserves.
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Your uncle repays a $100 loan from Tenth National Bank (TNB) by writing a $100 check from his TNB checking account. Use T-accounts to show the effect of this transaction on your uncle and on TNB. Has your uncle's wealth changed? Explain.
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What is commodity money? What is fiat money? Which kind do we use?
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If the reserve ratio is ¼ and the central bank increases the quantity of reserves in the banking system by $120, the money supply increases by
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Which of the following actions by the Fed would reduce the money supply?
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What is the discount rate? What happens to the money supply when the Fed raises the discount rate?
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Assume that the reserve requirement is 5 percent. All other things being equal, will the money supply expand more if the Fed buys $2,000 worth of bonds or if someone deposits in a bank $2,000 that she had been hiding in her cookie jar? If one creates more, how much more does it create? Support your thinking.
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Who is responsible for setting monetary policy in the United States? How is this group chosen?
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Chloe takes $100 of currency from her wallet and deposits it into her checking account. If the bank adds the entire $100 to reserves, the money supply _________, but if the bank lends out some of the $100, the money supply _________.
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A bank has capital of $200 and a leverage ratio of 5. If the value of the bank's assets decline by 10 percent, then its capital will be reduced to
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What distinguishes money from other assets in the economy?
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Beleaguered State Bank (BSB) holds $250 million in deposits and maintains a reserve ratio of 10 percent. a. Show a T-account for BSB. b. Now suppose that BSB's largest depositor withdraws $10 million in cash from her account. If BSB decides to restore its reserve ratio by reducing the amount of loans outstanding, show its new T-account. c. Explain what effect BSB's action will have on other banks. d. Why might it be difficult for BSB to take the action described in part (b)? Discuss another way for BSB to return to its original reserve ratio.
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