Question 1

After getting an additional $5,000 in excess reserves, Bank A gives Sarah Smith a $5,000 student loan, which her school deposits in Bank B. If the reserve requirement is 20 percent, this $5,000 increase in Bank A's excess reserves will allow Bank A and Bank B together to make:

Accepted Answer

The initial $5,000 deposit allows Bank A to loan out $4,000 (80% of $5,000, since 20% must be kept as reserves). When Sarah's school deposits the $5,000 in Bank B, Bank B can loan out $4,000 as well. Together, they can make $4,000 + $4,000 = $8,000 in new loans, plus the initial $5,000 loan, totaling $9,000.

Question 2

The money multiplier is equal to:

Accepted Answer

The money multiplier is equal to 1 divided by the reserve requirement. This formula indicates how much the money supply can increase for every dollar increase in reserves.

Question 3

In the economy, a maximum change in the money supply would be equal to an initial change in:

Accepted Answer

The maximum change in the money supply is equal to an initial change in excess reserves times the money multiplier. The money multiplier reflects how an initial deposit can lead to a larger increase in the total money supply.

Question 4

The maximum amount by which an economy's money supply can increase is equal to an initial change in:

Accepted Answer

The maximum amount by which an economy's money supply can increase is determined by the initial change in excess reserves divided by the reserve requirement, as this calculation represents the potential for the banking system to create new money through the lending process. This is known as the money multiplier effect.

Question 5

The maximum amount by which the money supply can change following an initial change in excess reserves in the depository institutions system can be determined by calculating:

Accepted Answer

Both A and B are correct methods for determining the maximum change in the money supply following an initial change in excess reserves. The money multiplier (1/reserve requirement) is used in method A to calculate the potential maximum expansion of the money supply. Method B directly uses the reserve requirement to find the initial change's impact on the money supply, essentially outlining the same process in a different format.

Question 6

The amount by which the money supply could change following an initial change in excess reserves in the depository institutions system can be determined from the formula:

Accepted Answer

The answer of The amount by which the money supply...

Question 7

The size of the money multiplier is:

Accepted Answer

The money multiplier is inversely related to the size of the reserve requirement because the higher the reserve requirement, the less capacity banks have to create new money through lending.

Question 8

If excess reserves in the depository institutions system are increased by $10 million and the reserve requirement is 10 percent, then the total money supply could increase by up to:

Accepted Answer

The total money supply could increase by up to $100 million because with a 10 percent reserve requirement, every dollar of excess reserves can support up to $10 of new deposits throughout the banking system (1/0.10 = 10). Therefore, $10 million in excess reserves could support up to $100 million in new money creation through the money multiplier effect.

Question 9

If excess reserves in the depository institutions system increase by $16 million and the reserve requirement is 20 percent, the maximum amount by which the money supply can increase is:

Accepted Answer

The maximum increase in the money supply is determined by the money multiplier, which is the reciprocal of the reserve requirement. With a 20% reserve requirement, the money multiplier is 1/0.20 = 5. Therefore, if excess reserves increase by $16 million, the maximum increase in the money supply is $16 million * 5 = $80 million.

Question 10

Assume the Federal Reserve injects $10 billion of new excess reserves into the depository institutions system. If the reserve requirement is 20 percent, how much new money could be created by this action?

Accepted Answer

The new money created can be calculated using the money multiplier formula, which is 1/reserve requirement. With a 20% reserve requirement, the multiplier is 1/0.20 = 5. Therefore, $10 billion of new excess reserves could potentially create $10 billion * 5 = $50 billion of new money.

Question 11

Assume RST Bank has a reserve requirement of 20 percent. If RST Bank borrows $3 million from the Fed, how much new money could be created in the depository institutions system as a result?

Accepted Answer

When RST Bank borrows $3 million from the Fed, it can lend out 80% of that amount due to the 20% reserve requirement. This initial $3 million can lead to a total money creation of $15 million in the banking system through the money multiplier effect, which is calculated as 1 divided by the reserve requirement (1/0.20 = 5). Therefore, $3 million * 5 = $15 million.

Question 12

If the reserve requirement were decreased from 20 percent to 15 percent, the money multiplier would:

Accepted Answer

The money multiplier is inversely related to the reserve requirement. Lowering the reserve requirement allows banks to lend more of their deposits, thereby increasing the money multiplier.

Question 13

Which of the following would cause the money supply to increase by less than the amount indicated by the money multiplier?

Accepted Answer

Both A and B would cause the money supply to increase by less than the amount indicated by the money multiplier. In A, if a financial institution lends less than its increase in excess reserves, it is not fully utilizing its capacity to expand the money supply through the lending process. In B, when a person borrows money and converts part of it to cash rather than depositing it all into a demand deposit account, it reduces the base for the money multiplier effect since cash does not contribute to the creation of new deposits as directly as money deposited in banks.

Question 14

The most common method for stimulating business and household borrowing from depository institutions is to:

Accepted Answer

Reducing the rate of interest makes borrowing cheaper for businesses and households, encouraging them to take out loans for investment or consumption, thereby stimulating economic activity.

Question 15

Increases in the money supply result in higher:

Accepted Answer

When the economy is at less than full employment, an increase in the money supply can lead to higher spending, output, and employment as there are idle resources that can be utilized.

Question 16

The price paid to borrow money, which is expressed as a percentage of the amount borrowed, is the:

Accepted Answer

The interest rate is the price paid to borrow money, expressed as a percentage of the amount borrowed.

Question 17

The interest rate is:

Accepted Answer

The interest rate is indeed the price paid to lenders for making loans (A), the price paid by borrowers to borrow money (B), and is calculated as a percentage of the amount borrowed (C), making all of the above statements correct.

Question 18

The quantity of loans demanded:

Accepted Answer

The quantity of loans demanded typically increases when the interest rate decreases because lower interest rates make borrowing more affordable, encouraging individuals and businesses to take out loans.

Question 19

An increase in the interest rate will lead to:

Accepted Answer

An increase in the interest rate makes borrowing more expensive, which typically leads to a decrease in both business investment spending and the amount of loans demanded, as businesses are less inclined to finance new projects or expansion with more expensive debt.

Question 20

An increase in the interest rate will:

Accepted Answer

An increase in the interest rate makes borrowing more expensive, which decreases the amount of loans demanded. Conversely, higher interest rates make lending more attractive, increasing the amount of loans supplied.

Quiz 8: Money Creation, Monetary Theory, and Monetary Policy