Econ: Chapter 25

What is a barter economy?
an economy that does not use money and in which people trade goods and services
directly for other goods and services
What are the four functions of money?
1. a medium of exchange
2. a unit of account
3. a store of value
4. a standard of deferred payment
Describe M1
1. the narrowest definition of the money supply
2. includes currency,
checking account balances, and traveler’s checks
Describe M2.
1. includes everything that is in M1, plus savings accounts, small-denomination time deposits (such as
certificates of deposit (CDs)), money market deposit accounts in banks, and noninstitutional money
market fund shares.
What are reserves?
deposits that the bank has retained rather than loaned out or
What are required reserves?
reserves that banks are legally required to hold
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What is the required reserve ratio?
The fraction of deposits that banks are required to
keep as reserves
What are excess reserves?
Any reserves banks hold over and above the legal
requirement
What is the simple deposit multiplier?
1.the ratio of the amount of deposits created by banks to the
amount of new reserves
2. 1/RR
Describe a fractional reserve banking system.
banks keep less than 100 percent of
deposits as reserves
Describe a bank run.
many depositors decide simultaneously to withdraw money from a
bank
Describe a bank panic.
many banks experience runs at the same time.
What is the Federal Reserve System
1. central bank of the U.S.
2. established in 1913 to stop bank panics
3. main role today is to carry out monetary policy
What is monetary policy?
the actions the Federal
Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives
What are the Fed’s three monetary policy tools?
open market operations, discount policy, and reserve
requirements
What are open market operations?
the buying and selling of Treasury securities by the Federal
Reserve
What are discount loans?
the loans the Fed makes to banks
What is the discount rate?
the interest rates the Fed charges on discount loans
Describe the Federal Open Market Committee (FOMC).
meets
in Washington, DC, eight times per year to discuss monetary policy.
Describe the quantity equation.
1. relates the money supply to the price level
2. M x V = P X Y
What is the velocity of money?
the
average number of times each dollar in the money supply is spent during the yea
Describe the quantity theory of money.
1. devised by Irving Fisher
2. assumes that the velocity of money is constant
When does a barter economy work?
in a double coincidence of wants, where both parties to the trade want what
the other one has
Describe the term fiat money.
1. paper currency is fiat money, which has no value except as money
2. has no
value as a commodity and is money because it has been declared money by the government and because
people have confidence in it.
Describe medium of exchange.
Money is the asset that we use to buy goods and services
Describe unit of account.
All goods and services are priced in terms of money
Describe store of value.
Dollars not spent on goods and services in one time period can be held for use
in the future.
Describe standard for deferred payment.
In the United States, contracts involving future payments
are usually written specifying payment in dollars.
What are the qualifications for an asset to serve as a medium of exchange.
it must be generally acceptable, of standardized quality,
durable, valuable relative to its weight, and divisible
Assets that are generally accepted in exchange for goods and services or for payment of debts are
specifically called
a. wealth.
b. net worth.
c. money.
d. capital.
c. money
A double coincidence of wants refers to
a. the situation in which a good that is used as money also has value independent of its use as
money.
b. the fact that for a barter trade to take place between two people, each person must want what the
other one has.
c. the idea that a barter economy is more efficient than an economy that uses money.
d. the situation where two parties are involved in a transaction where money is the medium of
exchange.
the fact that for a barter trade to take place between two people, each person must want what the
other one has
By making exchange easier, money allows for
a. a double coincidence of wants.
b. the possible risk of inflation.
c. specialization and higher productivity.
d. all of the above
c. specialization and higher productivity
If prisoners of war use cigarettes as money, then cigarettes are
a. token money.
b. fiduciary money.
c. fiat money.
d. commodity money.
d. commodity money
Money serves as a unit of account when
a. sellers are willing to accept it in exchange for goods or services.
b. it can be easily stored and used for transactions in the future.
c. prices of goods and services are stated in the monetary unit.
d. all of the above
c. prices of goods and services are stated in the monetary unit.
Money serves as a standard of deferred payment when
a. it can be easily stored today and used for transactions in the future.
b. repayment of debts is made using money units.
c. sellers are willing to accept it in exchange for goods or services.
d. all of the above
b. repayment of debts is made using money units
Which of the following conditions make a good suitable for use as a medium of exchange?
a. The good must be acceptable to (that is, usable by) most buyers and sellers.
b. The good should be of standardized quality, so that any two units are identical.
c. The good should be durable, valuable relative to its weight, and divisible.
d. all of the above
d. all of the above
Which of the following statements is correct?
a. Today, most governments in the world issue paper currency that is backed by gold and can be
redeemed for gold.
b. Paper currency has no value unless it is used as money.
c. Paper money is a commodity money.
d. all of the above
b. Paper currency has no value unless it is used as money.
a. money that has value independent of its use as money
b. an asset that has the ability to be easily converted into the medium of exchange
c. money that is authorized by a central bank and that does not have to be exchanged for gold or
some other commodity money
d. money issued by financial intermediaries, such as banks and thrift institutions, not the central bank
c. money that is authorized by a central bank and that does not have to be exchanged for gold or
some other commodity money
To economists
a. money is only those assets that serve as a medium of exchange.
b. money is only currency, checking account deposits, or traveler’s checks.
c. money can be narrowly or broadly defined, depending on the types of assets included.
d. None of the above. There is no official definition or measurement of the money supply today
c. money can be narrowly or broadly defined, depending on the types of assets included.
The sum of currency in circulation, checking account balances in banks, and holdings of traveler’s
checks equals
a. M1.
b. M2.
c. M1 + M2.
d. none of the above
a. M1.
Savings account balances, small-denomination time deposits, and noninstitutional money market fund
shares are
a. included only in M1.
b. included only in M2.
c. included in both M1 and M2.
d. financial assets that are not included in the money supply.
b. included only in M2.
Jill deposits $100 from her checking account into her savings account at the local bank. As a result of
this transaction
a. neither M1 nor M2 will change.
b. M2 will increase by $100.
c. M1 will decrease by $100.
d. both b and c are correct
c. M1 will decrease by $100
Which of the following statements is correct?
a. Currency is used much more often to make payments than checking account balances.
b. More than 80 percent of all goods and services are purchased with a check, rather than with
currency.
c. Most of the U.S. currency is held within the United States, but a small amount is actually outside
the borders of the United States.
d. all of the above
b. More than 80 percent of all goods and services are purchased with a check, rather than with
currency
Which of the following statements is true?
a. Today, U.S. law prohibits banks from paying interest on checking account deposits.
b. Today, people are not allowed to write checks against their savings account balances.
c. Today, the difference between checking accounts and savings accounts is greater than it was
before the banking reform in 1980.
d. all of the above
b. Today, people are not allowed to write checks against their savings account balances.
Which of the following are included in M2?
a. M1
b. savings account balances and small-denomination time deposits
c. balances in money market deposit accounts in banks, and noninstitutional money market fund
shares
d. all of the above
d. all of the above
In the definition of the money supply, where do credit cards belong?
a. M1
b. M2
c. both M1 and M2
d. Credit cards are not included in the definition of the money supply.
d. Credit cards are not included in the definition of the money supply.
Bill Gates holds money and wealth. He also earns an annual income. Which of the three is largest?
a. his money
b. his income
c. his wealth
d. All three of the above mean the same thing and are the same size.
c. his wealth
The key role that banks play in the economy is to
a. provide a market for stocks and bonds.
b. manage the money supply.
c. accept deposits and make loans.
d. serve as lenders of last resort.
c. accept deposits and make loans
Which of the following is an asset to a bank?
a. reserves
b. checking account deposits
c. savings account deposits
d. certificates of deposit
a. reserves
Which of the following is the largest asset of a typical bank?
a. loans
b. buildings
c. vault cash
d. checking account deposits
a. loans
Which of the following refers to the minimum fraction of deposits banks are required by law to keep
as reserves?
a. the quantity equation
b. the simple deposit multiplier
c. the required reserve ratio
d. the cash to deposit ratio
c. the required reserve ratio
Which of the following is the largest liability of a typical bank?
a. deposits
b. loans
c. reserves
d. treasury bills
a. deposits
If the required reserve ratio is 10 percent, then using the simple deposit multiplier, what is the total
increase in checking account deposits caused by an initial deposit of $1,000?
a. $100
b. $1,000
c. $10,000
d. $100,000
c. $10,000
The simple deposit multiplier equals
a. the inverse, or reciprocal, of the required reserve ratio.
b. the ratio of the amount of deposits created by banks to the amount of new reserves.
c. the formula used to calculate the total increase in checking account deposits from an increase in
bank reserves.
d. all of the above
d. all of the above
A higher required reserve ratio _________ the value of the simple deposit multiplier.
a. increases
b. decreases
c. leaves unchanged
d. nullifies
b. decreases
An increase in the amount of excess reserves that banks keep _________ the value of the real-world
deposit multiplier.
a. increases
b. decreases
c. leaves unchanged
d. nullifies
b. decreases
28. If Fenway Bank has $500 in deposits and $200 in reserves and the required reserve ratio is 10 percent,
then Fenway Bank has
a. $200 in excess reserves.
b. $50 in required reserves.
c. $50 in excess reserves.
d. $200 in required reserves.
b. $50 in required reserves
Whenever banks gain reserves and make new loans, the money supply ___________; and whenever
banks lose reserves, they reduce their loans and the money supply __________.
a. expands; expands
b. expands; contracts
c. contracts; contracts
d. contracts; expands
b. expands; contracts
A banking system in which banks keep less than 100 percent of deposits as reserves is called
a. the Federal Reserve System.
b. a fractional reserve banking system.
c. a fully-funded reserve system.
d. wildcat banking
b. a fractional reserve banking system.
When many depositors decide simultaneously to withdraw their money from a bank, there is
a. an increase in bank lending.
b. usually a decline in discount lending by the Fed.
c. a bank run.
d. inflation.
c. a bank run.
A bank panic occurs when
a. there is an increase in bank lending.
b. the central bank carries out open market purchases.
c. many banks experience runs at the same time.
d. many banks fail to attract depositors so their reserves increase significantly.
c. many banks experience runs at the same time.
The Federal Reserve System is
a. the central bank of the United States.
b. the institution that regulates all state banks.
c. the institution solely responsible for regulating the stock and bond markets.
d. the institution also known as the Treasury of the United States.
a. the central bank of the United States
There are ________ members of the Board of Governors, who are appointed by the President of the
United States to ________, non-renewable terms. One of the Board members is appointed Chairman
for a _________, renewable term.
a. nine; 7-year; eight-year
b. twelve; 4-year; four-year
c. seven; 14-year; four-year
d. fourteen; 4-year; four-year
c. seven; 14-year; four-year
The actions the Federal Reserve takes to manage the money supply and interest rates to pursue
economic objectives is called
a. fiscal policy.
b. open market operations.
c. monetary policy.
d. financial management
c. monetary policy.
The Fed uses three monetary policy tools. Which of the following is not one of those tools?
a. open market operations
b. discount policy
c. reserve requirements
d. federal funds rate setting
d. federal funds rate setting
Which of the following people vote on monetary policy at the Federal Open Market Committee
(FOMC) meetings?
a. the seven members of the Federal Reserve’s Board of Governors
b. the president of the Federal Reserve Bank of New York
c. four presidents from Federal Reserve banks other than the president of the Federal Reserve Bank
of New York (rotating basis)
d. all of the above
d. all of the above
To increase the money supply, the FOMC directs the trading desk, located at the Federal Reserve
Bank of New York to
a. buy U.S. Treasury securities from the public.
b. sell U.S. Treasury securities to the public.
c. print U.S. Treasury securities and put them out in circulation.
d. buy U.S. dollars in the foreign exchange market
buy U.S. Treasury securities from the public
The Fed conducts monetary policy primarily through
a. open market operations.
b. discount policy.
c. reserve requirements.
d. none of the above
a. open market operations
By raising the discount rate, the Fed encourages banks to make _________ loans to households and
firms, which will _________ checking account deposits and the money supply.
a. more; increase
b. more; decrease
c. fewer; increase
d. fewer; decrease
d. fewer; decrease
The theory concerning the link between the money supply and the price level that assumes the
velocity of money is constant is called
a. the quantity equation.
b. the quantity theory of money.
c. the constant velocity theory of money.
d. the purchasing power parity theory of money
b. the quantity theory of money
Velocity is defined as:
a. V = M/(P x Y).
b. V = M x P x Y.
c. V = M + P + Y.
d. V=(P x Y)/M.
d. V=(P x Y)/M.
If Irving Fisher was correct in his prediction about the value of velocity, then the quantity equation
can be written to solve for the inflation rate as follows:
a. Inflation rate = Growth rate of the money supply + Growth rate of real output.
b. Inflation rate = Growth rate of the money supply – Growth rate of real output.
c. Inflation rate = Growth rate of the money supply – Growth rate of velocity.
d. Inflation rate = Growth rate of the money supply + Growth rate of velocity.
b. Inflation rate = Growth rate of the money supply – Growth rate of real output
Which of the following predictions can be made using the growth rates associated with the quantity
equation?
a. If the money supply grows at a faster rate than real GDP, there will be inflation.
b. If the money supply grows at a slower rate than real GDP, there will be inflation.
c. If the money supply grows at the same rate as real GDP, the price level will fall.
d. none of the above
a. If the money supply grows at a faster rate than real GDP, there will be inflation
Money is
A) one’s assets net of one’s liabilities at any point in time.
B) the income one earns over a period of time.
C) an asset that people are willing to accept in exchange for goods and services.
D) a liability that people are willing to accept in exchange for goods and services.
an asset that people are willing to accept in exchange for goods and services.
. A major source of inefficiency in barter economies is that they require
A) more liquid stores of value than do monetary economies.
B) a standard of deferred payment to make trade possible.
C) that there is a double coincidence of wants in exchange.
D) All of the above are correct.
C) that there is a double coincidence of wants in exchange
By making exchange ________, money allows for ________ and higher ________.
A) easier; specialization; productivity
B) harder; generalization; productivity
C) harder; specialization; costs
D) easier; specialization; costs
A) easier; specialization; productivity
4. Which of the following is a function that money serves?
A) store of value
B) medium of exchange
C) unit of account
D) All of the above are correct.
D) All of the above are correct.
When a grocery store accepts your $5 bill in exchange for bread and milk, the $5 bill serves as a
A) unit of account.
B) store of value.
C) medium of exchange.
D) standard of deferred payment.
C) medium of exchange.
6. A farm worker gets paid today in money, but plans to spend the money next week. This illustrates which
function of money?
A) store of value
B) standard of deferred payment
C) unit of account
D) medium of exchang
A) store of value
Liquidity is defined as
A) the ease with which a given asset can be converted to a medium of exchange.
B) the ease with which a given asset can be converted to a standard of deferred payment.
C) the ease with which a given asset can be converted to a store of value.
D) the ease with which a given asset can be converted to a unit of account.
A) the ease with which a given asset can be converted to a medium of exchange
A car dealer sells you a car today in exchange for money in the future. This illustrates which function of
money?
A) unit of account.
B) store of value.
C) standard of deferred payment.
D) medium of exchange.
C) standard of deferred payment.
Gold is an example of
A) commodity money.
B) M1.
C) barter money.
D) fiat money.
A) commodity money
Paper currency is a
A) fiat money.
B) barter money.
C) commodity money.
D) bond.
A) fiat money.
Fiat money is generally issued by
A) brokerage firms.
B) major multinational corporations.
C) central banks.
D) private banks.
C) central banks
Iraqi dinars issued by the government of Saddam Hussein increased in value against the dollar for a period of
time after the collapse of the Hussein government. The authors of your textbook conclude that this event shows
that:
A) money issued by a government that no longer exists becomes a collector’s item and rises in value.
B) the presence of fewer goods and services will increase the value of money.
C) money may serve as a store of value even if it fails to serve as a medium of exchange.
D) anything can be used as money as long as people are willing to accept it in exchange for goods and
services.
D) anything can be used as money as long as people are willing to accept it in exchange for goods and
services.
The narrowest official definition of the money supply is
A) M1
B) L
C) M3
D) M2
A) M1
4. Most payments in the U.S. for good and services are made using:
A) currency.
B) checking account deposits.
C) gold.
D) traveler’s checks
B) checking account deposits
. A problem confronting government regarding the penny is that
A) it no longer serves as store of value.
B) it cost less to produce than its face value.
C) the metals used to produce the penny are in limited supply.
D) it cost more to produce than its face value.
D) it cost more to produce than its face value.
M2 includes M1 plus
A) checking account deposits, large-denomination time deposits, and noninstitutional money market fund
shares.
B) savings account balances, money market deposit accounts in banks, small-denomination time deposits,
and noninstitutional money market fund shares.
C) currency in circulation, checking account deposits in banks, and holdings of traveler’s checks.
D) currency in circulation, savings account balances, and small denomination time deposi
B) savings account balances, money market deposit accounts in banks, small-denomination time deposits,
and noninstitutional money market fund shares.
. If households in the economy decide to take money out of checking account deposits and put this money into
savings accounts this will initially
A) increase M1 and decrease M2.
B) decrease M1 and not change M2.
C) decrease M1 and increase M2.
D) decrease M1 and decrease M2.
B) decrease M1 and not change M2.
8. If you transfer all of your currency to your checking account, then initially M1 will ________ and M2 will
________.
A) not change; not change
B) increase; not change
C) decrease; increase
D) not change; increase
A) not change; not change
Assets are
A) something the firm owes to someone else.
B) a measure of a firm’s net worth.
C) something owned by or owed to a firm.
D) always greater than a firm’s liabilities
C) something owned by or owed to a firm
. Liabilities are
A) something owned by or owed to a firm.
B) included as part of a firm’s reserves.
C) a measure of a firm’s net losses.
D) something a firm owes to someone else.
D) something a firm owes to someone else.
1. Which of the following is an asset for a bank?
A) Deposits of its customers.
B) Loans.
C) Shareholders’ equity
D) Short-term borrowing
B) Loans
Which of the following is counted as a liability for a bank?
A) Bank Reserves
B) Bank Loans
C) Customer deposits
D) Securities
C) Customer deposits
. The portion of ________ that a bank does not loan out or spend on securities is known as ________.
A) deposits; securities
B) deposits; reserves
C) loans; securities
D) loans; reserves
B) deposits; reserves
A bank is legally required to hold a fraction of its ________ as ________.
A) loans; excess reserves
B) deposits; excess reserves
C) deposits; required reserves
D) loans; required reserves
C) deposits; required reserves
5. Suppose the reserve ratio is RR. Then,
A) Required Reserves = RR × Loans.
B) Required Reserves = RR × Actual Reserves.
C) Required Reserves = RR × Deposits.
D) Required Reserves = RR × Excess Reserves.
C) Required Reserves = RR × Deposits.
. If the bank of Wachovia receives a $10,000 deposit, and the reserve requirement is .1 how much can the bank
loan out? (Assume that before the deposit this bank is just meeting its legal reserve requirement.)
A) $10,000
B) $1,000
C) $11,000
D) $9,000
D) $9,000
. Suppose you deposit $2000 into Bank of America and that the required reserve ratio is .1. How does this affect
the bank’s balance sheet?
A) Deposits rise by $1,000.
B) Required reserves rise by $2000.
C) Excess reserves rise by $1,800.
D) Reserves rise by $200.
C) Excess reserves rise by $1,800.
If the reserve requirement percentage is .05 then the simple deposit multiplier is
A) 5
B) 10
C) 20
D) 2
C) 20
. With a required reserve ratio of 20 percent, an increase in reserves of $10,000 could lead to a maximum increase
in checking account deposits in the entire banking system of
A) $2,000.
B) $8,000.
C) $50,000.
D) $100,000.
C) $50,000
32. The ________ the reserve ratio, the ________ the money multiplier.
A) smaller; larger
B) smaller; smaller
C) larger; larger
D) None of the above are correct
A) smaller; larger
3. If banks do not loan out all their excess reserves then the real world multiplier is
A) smaller than 1/RR.
B) equal to 1/RR.
C) larger than 1/RR.
D) not related to 1/RR
A) smaller than 1/RR
When banks gain ________, they can ________ their loans; and the money supply ________.
A) reserves; increase; expands
B) withdrawals; increase; expands
C) reserves; increase; contracts
D) withdrawals; decrease; expands
A) reserves; increase; expands
A fractional reserve banking system is one in which banks hold less than 100 percent of _______ in reserves.
A) deposits
B) shareholder equity
C) securities
D) loans
A) deposits
Congress in 1913 established the Federal Reserve system with the intention of putting an end to
A) high interest rates.
B) bank panics.
C) inflation.
D) high unemployment rates.
B) bank panics
7. Bank panics have largely disappeared in the U.S. because
A) of deposit insurance.
B) banks are now required to hold a larger fraction of deposits as reserves.
C) bank loans are more closely monitored by the Federal Reserve.
D) of low interest rates.
A) of deposit insurance.
Which of the following is not a tool the Fed uses to manage the money supply?
A) open market operations
B) setting reserve requirements for deposits in the banking system.
C) setting the discount rate of interest.
D) expanding and contracting deposit insurance
D) expanding and contracting deposit insurance
. Which of the following is (are) responsible for managing the money supply in the United States?
A) The Federal Open Market Committee
B) The Board of Governors.
C) The twelve Federal Reserve Banks.
D) The Federal Reserve Bank of New York
A) The Federal Open Market Committee
1. The discount rate is
A) the interest rate banks charge each other for overnight loans.
B) the interest rate the Fed charges to banks for loans from the Fed.
C) the interest rate banks charge their best customers.
D) the interest rate the U.S. Treasury pays on Treasury Bills.
B) the interest rate the Fed charges to banks for loans from the Fed
. Lowering the discount rate will
A) decrease reserves, encourage banks to make fewer loans, and increase the money supply.
B) increase reserves, encourage banks to make more loans, and decrease the money supply.
C) increase reserves, encourage banks to make more loans, and increase the money supply.
D) decrease reserves, encourage banks to make fewer loans, and decrease the money supply.
C) increase reserves, encourage banks to make more loans, and increase the money supply.
If the Fed lowers the reserve requirement, then this
A) decreases excess reserves, causes banks to reduce their loans, and increases the money supply.
B) increases excess reserves, causes banks to reduce their loans, and increases the money supply.
C) increases excess reserves, encourages banks to make more loans, and increases the money supply.
D) decreases excess reserves, causes banks to reduce their loans, and decreases the money supply
C) increases excess reserves, encourages banks to make more loans, and increases the money supply
Which of the following is an appropriate policy for the Fed to pursue if it wants to increase the money supply?
A) raise the discount rate
B) raise the reserve requirement
C) lower taxes
D) buy U.S. treasury bills
D) buy U.S. treasury bills
. The quantity theory of money seeks to explain the connection between money and
A) unemployment.
B) interest rates.
C) output.
D) prices.
D) prices
The velocity of money is defined as
A) P×Y.
B) the average number of times each dollar is used to purchase goods and services.
C) the total number of times each dollar is used to purchase goods and services.
D)
M
P×Y
.
B) the average number of times each dollar is used to purchase goods and services
According to the quantity theory of money, inflation is caused by
A) GDP growing at the same rate as the money supply.
B) GDP growing faster than the money supply.
C) the money supply growing faster than real GDP.
D) the money supply growing slower than real GDP.
C) the money supply growing faster than real GDP.
8. According to the quantity theory of money, if the money supply grows at 6%, real GDP grows at 2%, and the
velocity of money is constant, then the inflation rate will be
A) 4%.
B) 2%.
C) 6%.
D) 8%.
A) 4%.
Hyperinflation is caused by
A) Real GDP growing more rapidly than the money supply.
B) the money supply growing more slowly than GDP.
C) a constant increase in the money supply.
D) a high rate of growth in the money supply.
D) a high rate of growth in the money supply