Question 1

Assume that banks do not hold excess reserves. The banking system has $50 million in reserves and has a reserve requirement of 10 percent. The public holds $20 million in currency. Then the public decides to withdraw $5 million in currency from the banking system. If the Bank of Canada wants to keep the money supply stable by changing the reserve requirement, then what will the new reserve requirement be?

Accepted Answer

Initially, banks have $50 million in reserves and the public holds $20 million in currency. Therefore, the total money supply is $70 million ($50 million reserves + $20 million currency in circulation). With a reserve requirement of 10 percent, the required reserves are $7 million ($70 million x 0.10). This means that banks have $43 million in excess reserves ($50 million - $7 million).

When the public withdraws $5 million in currency, the amount of reserves in the banking system decreases to $45 million ($50 million - $5 million). To keep the money supply stable, the Bank of Canada can change the reserve requirement. Let x be the new reserve requirement. Then, the required reserves become $7 million + $5 million = $12 million, and banks must hold $45 million x (x/100) = $12 million in reserves. Solving for x, we get x = 9.1 percent. Therefore, the new reserve requirement should be 9.1 percent.

Question 2

Which of the following best describes bank runs today?

Accepted Answer

Bank runs are uncommon today because of the CDIC deposit insurance, which guarantees that individual deposits up to a certain amount are insured in case of a bank failure. This reduces the likelihood of depositors withdrawing their funds en masse in the event of a crisis.

Question 3

How does currency contribute to the money supply?

Accepted Answer

Currency held by the public is considered part of the money supply because it is available for transactions and spending. However, currency held by banks is not counted in the money supply as it is considered as reserves, not actively circulating in the economy.

Question 4

How can the Bank of Canada directly protect a bank during a bank run?

Accepted Answer

The Bank of Canada can directly protect a bank during a bank run by lending reserves to the bank. This can provide the bank with the necessary liquidity to meet the demands of depositors and prevent a run from progressing further. Increasing reserve requirements, selling government bonds to the bank, or penalizing the bank in trouble may not be as effective in directly protecting the bank during a bank run.

Question 5

Which of the following happened during the Great Depression in the early 1930s?

Accepted Answer

The answer of Which of the following happened during the...

Question 6

In the nineteenth century when there were often bank runs caused by crop failures, banks would make relatively fewer loans and hold relatively more excess reserves. By itself, which of the following actions should the banks have done?

Accepted Answer

During bank runs caused by crop failures, banks should decrease both the money multiplier and the money supply. This is because the risk of default increases, and to cover the potential losses, banks should hold more excess reserves, which leads to a decrease in the money supply. Moreover, making relatively fewer loans and decreasing the money multiplier will reduce the likelihood of a bank run or a further decrease in the money supply.

Question 7

The banking system has $20 million in reserves and has a reserve requirement of 20 percent. Bankers previously did not hold any excess reserves, but difficult economic times make them decide that it is prudent to hold 25 percent of deposits as reserves. Other things equal, by how much must the Bank of Canada increase bank reserves to keep the money supply the same?

Accepted Answer

The initial total deposits are $100 million ($20 million in reserves divided by a reserve requirement of 20%).

With the decision to hold 25% of deposits as reserves, the new required reserves will be $25 million (25% of $100 million in deposits).

The current reserves of $20 million are only sufficient to cover the old reserve requirement of 20%. Therefore, the bank needs to increase its reserves by $5 million ($25 million - $20 million) to meet the new reserve requirement.

As a result, the Bank of Canada needs to increase bank reserves by $5 million to keep the money supply the same.

Question 8

The banking system has $20 million in reserves and has a reserve requirement of 20 percent. The public holds $20 million in currency. Bankers previously did not hold any excess reserves, but difficult economic times make them decide that it is prudent to hold 25 percent of deposits as reserves. At the same time, the public decides to deposit $6.7 million in currency into the banking system. Other things equal, what must the Bank of Canada do to bank reserves to keep the money supply the same?

Accepted Answer

The public's decision to deposit more currency into the banking system increases the money supply. To keep the money supply the same, the Bank of Canada must reduce reserves by the same amount, which is $6.7 million.

Question 9

Ralph deposits half of his inheritance in a savings account at the bank. In doing so, Ralph is using money as a medium of exchange.

Accepted Answer

The answer of Ralph deposits half of his inheritance in...

Question 10

Joe wants to trade eggs for sausage. Lashonda wants to trade eggs for orange juice. Joe and Lashonda have a double coincidence of wants.

Accepted Answer

While Joe and Lashonda have a coincidence of wants, it is not a double coincidence of wants as they are not looking for the same goods. Joe wants sausage and Lashonda wants orange juice, so they cannot simply exchange their respective goods with each other.

Question 11

Bottles of very fine wine are less liquid than demand deposits.

Accepted Answer

Very fine wines are considered luxury goods and their supply is limited, hence they have higher value per unit compared to demand deposits which are readily available for immediate use as a medium of exchange. Therefore, bottles of very fine wine are less liquid than demand deposits.

Question 12

Which of the following explains the role of the Canadian Deposit Insurance Corporation (CDIC)?

Accepted Answer

The CDIC's main role is to protect depositors by insuring eligible deposits up to a certain amount in the event of a member financial institution's failure.

Question 13

The banking system has $20 million in reserves and has a reserve requirement of 20 percent. The public holds $10 million in currency. Bankers previously did not hold any excess reserves, but difficult economic times make them decide that it is prudent to hold 25 percent of deposits as reserves. At the same time, the public decides to withdraw $10 million in currency from the banking system. Other things equal, by how much must the Bank of Canada increase bank reserves to keep the money supply the same?

Accepted Answer

The public withdraws $10 million, reducing deposits and requiring banks to hold more reserves. To maintain the money supply, the Bank of Canada must increase reserves by $12.5 million to offset the withdrawal and increased reserve ratio.

Question 14

In an economy that relies on barter, trade requires a double coincidence of wants.

Accepted Answer

In a barter economy, goods and services are exchanged directly without the use of money. In such an economy, a double coincidence of wants is necessary for trade to occur, which means that both parties must want what the other has and be willing to trade for it.

Question 15

When the Soviet Union began breaking up in the late 1980s, cigarettes began replacing the ruble as the medium of exchange, even though the ruble was legal tender. The cigarettes provide an example of fiat money.

Accepted Answer

Cigarettes in this context are considered commodity money, not fiat money, because their value comes from a physical commodity rather than being decreed by a government as legal tender.

Question 16

Which of the following best explains whether bank runs are a problem for the economy?

Accepted Answer

Bank runs are a problem because they can lead to bank failures, which may then spread to healthy banks. This can cause a domino effect, leading to a contraction of the money supply and a decrease in the money multiplier. The central bank can try to prevent or stop bank runs by providing a lender of last resort function, but this is not always successful. Therefore, bank runs are a potential problem for the economy.

Question 17

Marc puts prices on surfboards and skateboards at his sporting goods store. He is using money as a unit of account.

Accepted Answer

Using money as a unit of account means assigning prices to goods and services. Marc is assigning prices to surfboards and skateboards in his sporting goods store, which is an example of using money as a unit of account.

Question 18

Gary's wealth is $1 million. Economists would say that Gary has $1 million worth of money.

Accepted Answer

Economists would say that Gary has $1 million worth of wealth, not necessarily money. Wealth includes all assets of value, such as property, stocks, and bonds, not just money.

Question 19

Assume that banks do not hold excess reserves. The banking system has $20 million in reserves and has a reserve requirement of 20 percent. The public holds $10 million in currency. Then the public decides to withdraw $5 million in currency from the banking system. If the Bank of Canada wants to keep the money supply stable by changing the reserve requirement, then what will the new reserve requirement be?

Accepted Answer

Initially, the banking system has $20 million in reserves and a reserve requirement of 20 percent. This means that the total deposits in the banking system are $100 million ($20 million / 0.20).

When the public withdraws $5 million in currency, the reserves in the banking system decrease to $15 million. This means that the total deposits in the banking system are now $75 million ($15 million / 0.20).

To keep the money supply stable, the Bank of Canada needs to increase the reserves in the banking system back to $20 million. This can be done by reducing the reserve requirement.

Let x be the new reserve requirement. Then we have:

$10 million + $75 million * x = $20 million

Solving for x, we get:

x = 15.8 percent

Therefore, the new reserve requirement is 15.8 percent. Choice C is the correct answer.

Question 20

The use of money allows trade to be roundabout.

Accepted Answer

Money serves as a medium of exchange and allows for indirect exchanges, which makes trade roundabout. Instead of directly exchanging goods or services, individuals can use money to buy a good or service that they need from someone else who accepts that same currency. This indirect exchange is what allows for greater specialization and efficiency in the market.

Quiz 10: The Monetary System