Economics Study Set 17

Business

Quiz 29 :

Money and the Banking System

Quiz 29 :

Money and the Banking System

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Suppose banks keep no excess reserves and no individuals or firms hold on to cash. If someone suddenly discovers $12 million in buried treasure and deposits it in a bank, explain what will happen to the money supply if the required reserve ratio is 10 percent.
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Money multiplier
Money multiplier refers to the effect of change in money supply due to a change in the money base.
Change in the money supply
Assume in an economy, banks have no excess reserves and public or firms do not hold cash in hand. A person gets $12 million worth of treasure and deposits that amount in the bank with a 10 percent of required reserve ratio.
To calculate the money supply, substitute the above details in Equation (1):
img ……(1)
Where,
img money supply
D = change in the deposit
m = required reserve ratio
img The deposit of $12 million with the required reserve ratio of 10 percent leads to an increase in the money supply by 10 times of the deposit, that is, $120 million.

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Since 2008 a rash of bank failures has occurred in the United States. Explain why these failures did not lead to runs on banks.
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Bank failures
The banks were vulnerable to bank runs. Hence, there were two policies followed by the bankers.
They are:
• To maintain minimum decent reserves that will increase the liquidity of banks to meet economic shocks.
• To be watchful in lending; this will avoid bad debts and the banks will not lose their reputation among customers.
Bank failures and bank runs
Although several banks in the United States had great falls and failures, there were no runs evidenced during 2008. This was mainly due to the implementation of an insurance system called deposit insurance. This insurance system ensured the depositors that they will not lose their deposit money even at the event of bankruptcy.
This gave the customers or the public a confidence and belief to deposit money in the banks. This system rescued the banks from runs even at their fall.

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How would your answer to Test Yourself Question 1 differ if the reserve ratio were 25 percent If the reserve ratio were 100 percent Reference Test Yourself Question 1 Suppose banks keep no excess reserves and no individuals or firms hold on to cash. If someone suddenly discovers $12 million in buried treasure and deposits it in a bank, explain what will happen to the money supply if the required reserve ratio is 10 percent.
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Answer:

Answer:

Money multiplier
Money multiplier refers to the effect of change in money supply due to a change in the money base.
Change in the money supply when reserve ratio is 25 percent
Assume in an economy, banks have no excess reserves and public or firms do not hold cash in hand. A person gets $12 million and deposits the amount in the bank with a 25 percent of required reserve ratio.
To calculate the money supply, substitute the above details in Equation (1):
img ……(1)
Where,
img money supply
D = change in the deposit
m = required reserve ratio
img The deposit of $12 million with the required reserve ratio of 25 percent leads to an increase in the money supply by 4 times of the deposit, that is, $48 million.
Change in the money supply when reserve ratio is 100 percent
Assume in an economy, banks have no excess reserves and public or firms do not hold cash in hand. A person gets $12 million and deposits the amount in the bank with a 100 percent of required reserve ratio.
To calculate the money supply, substitute the above details in Equation (1):
img ……(1)
Where,
img money supply
D = change in the deposit
m = required reserve ratio
img The deposit of $12 million with the required reserve ratio of 100 percent leads to an increase in the money supply by 10 times of the deposit, that is, $12 million.

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What is fractional reserve banking, and why is it the key to bank profits (Hint: What opportunities to make profits would banks lose if reserve requirements were 100 percent ) Why does fractional reserve banking give bankers discretion over how large the money supply will be Why does it make banks potentially vulnerable to runs
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How is "money" defined, both conceptually and in practice Does the U.S. money supply consist of commodity money, full-bodied paper money, or fiat money
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Use tables such as Tables 2 and 3 to illustrate what happens to bank balance sheets when each of the following transactions occurs: a. You withdraw $100 from your checking account to buy concert tickets. b. Sam finds a $100 bill on the sidewalk and deposits it into his checking account. c. Mary Q. Contrary withdraws $500 in cash from her account at Hometown Bank, carries it to the city, and deposits it into her account at Big City Bank.
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If ours were a barter economy, how would you pay your tuition bill What if your college did not want the goods or services you offered in payment
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If the government takes over a failed bank with liabilities (mostly deposits) of $2 billion, pays off the depositors, and sells the assets for $1.5 billion, where does the missing $500 million come from Why
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For each of the transactions listed in Test Yourself Question 3, what will be the ultimate effect on the money supply if the required reserve ratio is one-eighth (12.5 percent) Assume that the oversimplified money multiplier formula applies. Reference Test Yourself Question 3 Use tables such as Tables 2 and 3 to illustrate what happens to bank balance sheets when each of the following transactions occurs: a. You withdraw $100 from your checking account to buy concert tickets. b. Sam finds a $100 bill on the sidewalk and deposits it into his checking account. c. Mary Q. Contrary withdraws $500 in cash from her account at Hometown Bank, carries it to the city, and deposits it into her account at Big City Bank.
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Each year during the Christmas shopping season, consumers and stores increase their holdings of cash. Explain how this development could lead to a multiple contraction of the money supply. (As a matter of fact, the authorities prevent this contraction from occurring by methods explained in the next chapter.)
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Excess reserves make a bank less vulnerable to runs. Why, then, don't bankers like to hold excess reserves What circumstances might persuade them that it would be advisable to hold excess reserves
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