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1 Hmwk Let's find out what counts as money. In this chapter, we used a typical definition of money: A widely accepted means of payment. Under this definition, which people are using money in the following transactions: i) Lucy sells her Saab to Karen for \$1,000 in cash. ii) Lucy sells her Saab to Karen for \$1,000 worth of old Bob Dylan records. iii) Lucy sells her Saab to Karen for \$1,000 in checking account balances (transferred by writing a check). iv) Lucy sells her Saab to Karen by Karen promising \$1,000 worth of auto-dealing services over the next year. v) Lucy sells her Saab to Karen for \$1,000 worth of Revolutionary War-era continental dollars. A. transactions i and v B. transactions iii and iv C. transactions i and ii 2. Fill in the blanks for the following definitions of the money supply: is currency and total reserves held at the Fed. is currency plus checkable deposits. is M1 plus savings deposits, money market mutual funds, and small time deposits. A. Monetary Base (MB); M1; M2 B. M2; M1; Monetary Base (MB) C. M1; Monetary Base (MB); M2 D. Monetary Base (MB); M2; M1 3. Suppose that banks have decided to keep a reserve ratio of 10 percent. This guarantees that they'll have enough cash in ATM machines to keep depositors happy and enough electronic deposits at the Federal Reserve so that they can redeem checks presented by other banks. What is the money multiplier in this case? A. 10 percent B. 1 C. 1% D Complete the following sentences: If depositors start visiting the ATM a lot more often, banks will have to the reserve ratio. This will lead to a money multiplier. A. increase; higher B. lower; lower C. increase; lower D. lower; higher 5. If the Federal Reserve wants to lower interest rates via open-market operations, should it buy 1 of 11 12/11/11 5:42 AM

2 bonds or should it sell bonds? A. The Fed should sell bonds. B. The Fed should buy bonds. C. The Fed cannot lower interest rates by buying or selling bonds. D. The Fed should sell and then buy back bonds. 6. Practice with money multipliers. Think of the money supply (MS) as equal to either M1 or M2: RR = 5%, Changes in reserves = \$10 billion. MM =?; Change in MS =? A. MM=20; MS=\$200 billion B. MM=5; MS=\$50 billion C. MM=10; MS=\$100 billion D. MM=1; MS =\$10 billion 7. Practice with money multipliers. Think of the money supply (MS) as equal to either M1 or M2: RR = 20%, Changes in reserves = -\$1,000. MM =?; Change in MS =? A. MM=20; MS=-\$20,000 B. MM=20; MS=-\$5,000 C. MM=5; MS=-\$1, Practice with money multipliers. Think of the money supply (MS) as equal to either M1 or M2: RR = 100%, Changes in reserves = \$10 billion. MM =?; Change in MS =? A. MM=100; MS=\$1,000 B. MM=1; MS= \$10 billion C. MM= 1; MS= \$1 billion D. MM= 10; MS= \$100 billion 9. Some economists have recommended that all banks be required by law to keep 100 percent of their deposits in the bank vault, at the Federal Reserve, or invested in ultrasafe investments such as short-term U.S. Treasury bills. If this happened, what would probably happen to the interest rate on bank deposits? A. The interest rate on bank deposits would probably not be affected by this. B. The interest rate on bank deposits would probably not increase. C. The interest rate on bank deposits would probably decrease. 2 of 11 12/11/11 5:42 AM

3 10. Some economists have recommended that all banks be required by law to keep 100 percent of their deposits in the bank vault, at the Federal Reserve, or invested in ultrasafe investments such as short-term U.S. Treasury bills. How would this probably affect the way people invest their savings? A. People would want to save more in banks since they would offer a higher interest rate on deposits. B. People would want to save less in banks and save more in bank alternatives (bonds or money market mutual funds). C. People would want to save more in banks since they would offer a lower interest rate on deposits. 11. The main interest rate that the Federal Reserve tries to control is the Federal Funds rate, the interest rate that banks charge on short-term (usually overnight) loans to other banks. Let's see how much interest a bank can earn if it lends money at the Federal Funds rate: Virginia Community Bank has \$2,000,000 of extra cash sitting in its account at the Federal Reserve Bank of Richmond. It gets a call from Bank of America asking to borrow the whole \$2,000,000 for 24 hours. If the annual interest rate on federal funds is 4 percent, what is the one-day interest rate on federal funds? A. approximately 0.011% per day B. approximately 4% per day C. approximately 1.1% per day D. approximately 2% per day 12. The main interest rate that the Federal Reserve tries to control is the Federal Funds rate, the interest rate that banks charge on short-term (usually overnight) loans to other banks. Let's see how much interest a bank can earn if it lends money at the Federal Funds rate: Virginia Community Bank has \$2,000,000 of extra cash sitting in its account at the Federal Reserve Bank of Richmond. It gets a call from Bank of America asking to borrow the whole \$2,000,000 for 24 hours. If the annual interest rate on federal funds is 4 percent, how many dollars of interest will Virginia Community Bank earn for lending this money for one day? A. \$80,000 B. \$8,000 C. \$220 D. \$220, Let's use the model of the supply and demand for bank reserves to explain how the Federal Reserve can change aggregate demand in the short run. After a meeting, the Federal Reserves Open Market Committee votes to cut interest rates from 2 percent to 1.5 percent. How will they make this happen? 3 of 11 12/11/11 5:42 AM

4 A. The Fed will decrease demand for bank reserves. B. The Fed will increase demand for bank reserves. C. The Fed will decrease the supply of bank reserves. D. The Fed will increase the supply of bank reserves. 14. Let's use the model of the supply and demand for bank reserves to explain how the Federal Reserve can change aggregate demand in the short run. After a meeting, the Federal Reserves Open Market Committee votes to cut interest rates from 2 percent to 1.5 percent. What will happen to the nation's money supply? A. it will increase B. it will decrease C. it will stay the same 15. After a meeting, the Federal Reserves Open Market Committee votes to cut interest rates from 2 percent to 1.5 percent. What will likely happen to aggregate demand in this case? A. it will decrease B. it will increase C. It will not be affected by the decrease in interest rates. D. It depends upon the short run position of the economy: If the economy is below its potential growth rate than the aggregate demand will decrease. If the economy is above its potential growth rate than the aggregate demand will increase. 16. We mentioned that the central bank can influence a short-run real interest rate. This is because in the short run the inflation rate is relatively constant but the central bank can adjust the nominal rate on short-term loans. Recall that after investing in a T-bill, the real rate that investors receive is: Real interest rate = Nominal interest rate Inflation. If inflation is 3 percent and the Fed wants the real rate on short-term loans to be 2 percent, where should it set the nominal Fed Funds rate? A. 2 percent B. 3 percent C. 2.5 percent D. 5 percent 17. We mentioned that the central bank can influence a short-run real interest rate. This is because in the short run the inflation rate is relatively constant but the central bank can adjust the nominal rate on short-term loans. Recall that after investing in a T-bill, the real rate that investors receive is: Real interest rate = Nominal interest rate Inflation. If inflation is 3 percent and the Fed wants to encourage borrowing by cutting the real rate on short-term loans to -1 percent, where should it set the nominal Fed Funds rate? 4 of 11 12/11/11 5:42 AM

5 A. 2 percent B. 3 percent C. 4 percent 18. What is the relationship between government-run central banks and deposit insurance institutions with the problem of moral hazard? A. Both central banks and deposit insurance institutions increase moral hazard problems because they might take on too much risk. B. Both central banks and deposit insurance institutions increase moral hazard problems because they might take on too little risk. C. Both central banks and deposit insurance institutions decrease moral hazard problems because they might take on too much risk. D. Both central banks and deposit insurance institutions increase moral hazard problems because they are immoral institutions. 19. Fill in the blanks for the following sentences: In the short run, if the Fed wants to cut short-term, nominal interest rates, it will the growth rate of money. This will tend to the real interest rate. A. decrease; increase B. increase; increase C. increase; decrease D. decrease; decrease 20. In the long run, if the Fed wants to decrease the nominal interest rate what will it do? A. The Fed would increase the growth rate of money. B. The Fed would decrease the growth rate of money. C. The Fed would continuously buy government bonds. D. The Fed would continuously lower the minimum required reserve ratio of banks. 21. Let's watch a bank create money. Last Wednesday, the Bank of Numenor opened for business. The first customer, Edith, walked in the door with 100 pieces of silver to deposit in a new checking account. The second customer, Max, walked in the door a few minutes later, asking to borrow 50 pieces of silver for a week. The bank lent Max the silver. Just to keep things simple, assume these are the only financial transactions in Numenor. And just to be clear: silver pieces are either currency or reserves. Silver in Max or Edith's hands is currency, while silver in the bank is reserves. How much money is there in the Numenor economy after the Bank made the loan to? 5 of 11 12/11/11 5:42 AM

6 A. MB = 100 pieces; M1= 100 pieces B. MB = 50 pieces; M1 = 50 pieces C. MB = 100 pieces; M1 = 150 pieces D. MB = 150 pieces; M1 = 100 pieces 22. You are a bank regulator working for the Federal Reserve. It is your job to determine whether banks are solvent or insolvent, liquid or illiquid. What would you state about the Bank of Escondido that has the following characteristics: Short-term assets = \$6 million; Short-term liabilities = \$10 million; Total assets = \$50 million and Total liabilities = \$40 million. A. liquid and solvent B. illiquid but solvent C. liquid but insolvent D. illiquid and insolvent 23. In the past, the Federal Reserve didn't pay interest on reserves kept in Federal Reserve banks: For an ordinary U.S. bank, money kept at the Fed earned zero interest, just like money stored in a vault or in an ATM machine. In 2008, the Fed started paying interest on deposits kept at the Fed. If a central bank starts paying interest on reserves, how is this likely to affect the amount of loans made by private banks, holding all else equal? A. All else equal, banks will probably make fewer loans. B. All else equal, banks will probably make more loans. C. All else equal, this would probably not affect the amount of loans being made by private banks. D. Private banks do not make loans, only the Fed is permitted to make loans to private customers. 24. Section: Fractional Reserve Banking, the Reserve Ratio, and the Money Multiplier Suppose the reserve ratio in the banking system is 50%. If the Fed decreases bank reserves by \$200, then the money supply will: A. increase by \$1,000. B. decrease by \$1,000. C. increase by \$400. D. decrease by \$ Section: Open Market Operations Open market operations refer to: 6 of 11 12/11/11 5:42 AM

7 A. the Fed's spending in different markets of the economy. B. the Fed's buying and selling government bonds. C. private banks' lending practices. D. the Treasury's operations in foreign exchange markets. 26. Section: Revisiting Aggregate Demand and Monetary Policy In the short run, an increase in the growth rate of money supply leads to: A. a decrease in aggregate demand, an increase in the inflation rate but a decrease in the real growth rate. B. an increase in aggregate demand, an increase in the inflation rate but a decrease in the real growth rate. C. an increase in aggregate demand, a decrease in the inflation rate but an increase in the real growth rate. D. an increase in aggregate demand, and an increase in both the inflation and real growth rate. 27. Section: The Federal Reserve and Systemic Risk Which of the following best describes the condition in which banks take too much risk in the hope that the Fed will later bail them out? A. systemic risk B. moral hazard C. solvency crisis D. liquidity crisis 28. Section: The U.S. Money Supplies If a person makes a deposit into her savings account with cash, then: A. M1 will decrease while M2 will increase. B. M1 will increase while M2 decrease. C. M1 will decrease while M2 will remain unchanged. D. both M1 and M2 will remain unchanged. 29. Section: The U.S. Money Supplies Refer to the following table. The amount of M1 equals: Currency \$100 7 of 11 12/11/11 5:42 AM

8 Savings deposits \$50 Checkable deposits \$80 Money market mutual funds \$15 Small time deposits \$10 A. \$110 B. \$180 C. \$230 D. \$ Which of the following is not a function of the Federal Reserve? A. serving as the lender of last resort B. regulating the U.S. financial system C. regulating the U.S. money supply D. providing loans to small businesses 31. Why are debit cards not listed as money? A. Because they perform the same function as checks, and checks are counted as money. B. Debit cards cannot be used for payments at most stores. C. Debit cards draw on checkable deposits, which are already counted as money. D. Not all banks issue debit cards. 32. Reference: Ref 14-1 (Table: Statistics for a Small Economy) The table above shows some statistics for a small economy. Using only the information provided, M1 in this country amounts to: 8 of 11 12/11/11 5:42 AM

9 A. \$36 million. B. \$57 million. C. \$23 million. D. \$50 million. 33. Reference: Ref 14-1 (Table: Statistics for a Small Economy) The table above shows some statistics for a small economy. Using only the information provided, the monetary base amounts to: A. \$149 million. B. \$71 million. C. \$19 million. D. \$12 million. 34. What part of the money pyramid does the Fed have direct control over? A. the monetary base B. M1 C. the monetary base plus M1 D. M2 35. The Federal Funds rate is the interest rate charged on a(n): A. low interest loan from the Federal Reserve to a bank. B. loan from the Federal Reserve to a bank. C. long-term loan from one bank to another. D. overnight loan from one bank to another. 36. When banks borrow directly from the Fed, the interest rate they pay is called the: 9 of 11 12/11/11 5:42 AM

10 A. prime rate. B. discount rate. C. Federal Funds rate. D. required reserve rate. 37. Systemic risk is: A. the risk of contagion that occurs when a failing financial institution owes significant sums of money to other financial institutions. B. a risk that is limited to a specific sector only. C. the risk of a bubble in the entire asset pricing system. D. the risk that, when a financial institution fails, its depositors will not only lose their money but also their trust in the monetary system. 38. What was the rationale for the Fed lending billions of dollars to the insurance company American International Group (AIG)? A. The Fed knew it would receive a high return on the loan. B. The Fed was following a long-time precedent in rescuing top insurance companies. C. If AIG collapsed, the insurance industry would as well. D. The money AIG owed to banks posed a systemic risk. 39. Which of the following is an example of moral hazard? A. Only people with very high risk of default on loans borrow from banks. B. Drivers have less incentive to avoid accidents after getting auto insurance. C. When one bank fails, other banks become more cautious in lending. D. People living along the Gulf Coast are more likely to buy flood insurance. 40. Figure: AD and Monetary Policy 10 of 11 12/11/11 5:42 AM

11 Reference: Ref 14-5 (Figure: AD and Monetary Policy) Suppose in a given economy, we start at point A as shown in the figure above. If the Fed engages in an expansionary monetary policy, what would you expect to happen in the short run? A. Aggregate supply will decrease because of higher wages. B. Aggregate demand will decrease because of lower interest rates. C. Aggregate demand will increase because of lower interest rates. D. The economy will return to the Solow growth rate. 11 of 11 12/11/11 5:42 AM

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