The Monetary System

TRUE/FALSE
6. When money functions as a unit of account, then it cannot be commodity money.
7. Demand deposits are balances in bank accounts that depositors can access by writing a check.
8. According to economists, a collection of valuable jewels is not money.
9. A debit card is more similar to a credit card than to a check.
10. Gary's wealth is $1 million. Economists would say that Gary has $1 million worth of money.
11. Marc puts prices on surfboards and skateboards at his sporting goods store. He is using money as a unit of
account.
12. Sandra routinely uses currency to purchase her groceries. She is using money as a unit of account.
13. Bottles of very fine wine are less liquid than demand deposits.
14. U.S. dollars are an example of commodity money and hides used to make trades are an example of fiat money.
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.
16. In order for currency to be widely used as a medium of exchange, it is sufficient for the government to
designate it as legal tender.
17. M1 includes savings deposits.
18. M2 is both larger and more liquid than M1.
19. Credit cards are a medium of exchange.
20. The series of bank failures in 1907 occurred despite the creation of the Federal Reserve many years earlier.
26. The Federal Reserve primarily uses open-market operations to change the money supply.
27. If the Fed buys bonds in the open market, the money supply decreases.
28. Banks cannot influence the money supply if they hold all deposits in reserve.
29. Banks still could contribute to changes in the money supply, even if they were required to hold all deposits in
reserve.
30. If banks hold any amount of their deposits in reserve, then they do not have the ability to influence the money
supply.
31. When the Federal Reserve decreases the discount rate, the quantity of reserves increases and the money supply
increases.
32. The money multiplier equals 1/(1 - R), where R represents the reserve ratio.
33. Assume that when $100 of new reserves enter the banking system, the money supply ultimately increases by
$625. Assume also that no banks hold excess reserves and that the entire money supply consists of bank
deposits. If, at a point in time, reserves for all banks amount to $500, then at that same point in time, loans for
all banks amount to $2,625.
34. Assume that when $100 of new reserves enter the banking system, the money supply ultimately increases by
$800. Assume also that no banks hold excess reserves and that the entire money supply consists of bank
deposits. If, at a point in time, reserves for all banks amount to $750, then at that same point in time, loans for
all banks amount to $6,000.
35. As banks create money, they create wealth.
36. The money supply of Hooba is $10,000 in a 100-percent-reserve banking system. If Hooba decreases the
reserve requirement to 10 percent, the money supply could increase by no more than $9,000.
37. If the Fed decreases reserve requirements, the money supply will increase.
38. An increase in reserve requirements increases reserves and decreases the money supply.
39. Just after the terrorist attack on September 11, 2001, the Fed stood ready to lend financial institutions funds.
When the Fed did this, it was acting in its role of lender of last resort.
40. Because of the multiple tools at its disposal, the Fed can control the money supply very precisely.
41. In the months of November and December, people in the United States hold a larger part of their money in the
form of currency because they intend to shop and travel for the holidays. As a result, other things the same the
money supply increases.
42. Other things the same, if banks decide to hold a smaller part of their deposits as excess reserves, the money
supply will fall.
43. Bank runs and the accompanying increase in the money multiplier caused the U.S. money supply to rise by 28
percent from 1929 to 1933.

1950
SHORT ANSWER
1. Economists argue that the move from barter to money increased trade and production. How is this possible?
2. What is the difference between money and wealth?
3. Which of the three functions of money are commonly met by each of the following assets in the U.S.
economy?
a. paper dollar
b. precious metals
c. collectibles such as baseball cards, stamps, and antiques
4. Are credit cards and debit cards money? What's the difference between credit and debit cards?
5. What is the difference between commodity money and fiat money? Why do people accept fiat money in trade
for goods and services?
7. What is meant by the term "lender of last resort?" In what circumstances might the Fed be a lender of last
resort?
12. Explain why banks can influence the money supply if the required reserve ratio is less than 100 percent.
13. If the reserve ratio is 20 percent, how much money can be created from $100 of reserves? Show your work.
14. Draw a simple T-account for First National Bank which has $5,000 of deposits, a required reserve ratio of 10
percent, and excess reserves of $300. Make sure you balance sheet balances.
15. Explain how each of the following changes the money supply.
a. the Fed buys bonds
b. the Fed raises the discount rate
c. the Fed raises the reserve requirement
16. Describe the two things that limit the precision of the Fed's control of the money supply and explain how each
limits that control.
17. During the early 1930s there were a number of bank failures in the United States. What did this do to the
money supply? The New York Federal Reserve Bank advocated open market purchases. Would these
purchases have reversed the change in the money supply and helped banks? Explain.
18. Suppose that in a country the total holdings of banks were as follows:
required reserves = $45 million
excess reserves = $15 million
deposits = $750 million
loans = $600 million
Treasury bonds = $90 million
Show that the balance sheet balances if these are the only assets and liabilities.
Assuming that people hold no currency, what happens to each of these values if the central bank changes the reserve
requirement ratio to 3%, banks still want to hold the same percentage of excess reserves, and banks don’t change
their holdings of Treasury bonds? How much does the money supply change by?

Sec00 - The Monetary System

MULTIPLE CHOICE
11. The measure of the money stock called M1 includes
a. wealth held by people in their checking accounts.
b. wealth held by people in their savings accounts.
c. wealth held by people in money market mutual funds.
d. everything that is included in M2 plus some additional items.
12. Credit cards are
a. a medium of exchange.
b. counted as part of M2 but not as part of M1.
c. important for analyzing the monetary system.
d. All of the above are correct.
13. The set of items that serve as media of exchange clearly includes
a. demand deposits.
b. short-term bonds.
 c. credit cards.
d. All of the above are correct.
14. The set of items that serve as media of exchange clearly includes
a. balances that lie behind debit cards.
b. demand deposits.
c. deposits other than demand deposits, such as NOW accounts, on which checks can be written.
d. All of the above are correct.
15. Dollar bills, rare paintings, and emerald necklaces are all
a. media of exchange.
b. units of account.
c. stores of value.
d. All of the above are correct.
16. Imagine an economy in which: (1) pieces of paper called yollars are the only thing that buyers give to sellers
when they buy goods and services, so it would be common to use, say, 50 yollars to buy a pair of shoes; (2)
prices are posted in terms of yardsticks, so you might walk into a grocery store and see that, today, an apple is
worth 2 yardsticks; and (3) yardsticks disintegrate overnight, so no yardstick has any value for more than 24
hours. In this economy,
a. the yardstick is a medium of exchange but it cannot serve as a unit of account.
b. the yardstick is a unit of account but it cannot serve as a store of value.
c. the yardstick is a medium of exchange but it cannot serve as a store of value, and the yollar is a unit
of account.
d. the yollar is a unit of account, but it is not a medium of exchange and it is not a liquid asset.
17. Money is
a. the most liquid asset and a perfect store of value.
b. the most liquid asset but an imperfect store of value.
c. the least liquid asset but a perfect store of value.
d. the least liquid asset and an imperfect store of value.
18. Paper dollars
a. are commodity money and gold coins are fiat money.
b. are fiat money and gold coins are commodity money.
c. and gold coins are both commodity monies.
d. and gold coins are both fiat monies.
20. Currency includes
a. paper bills and coins.
b. demand deposits.
c. credit cards.
d. Both (a) and (b) are correct.
21. Which of the following is not included in M1?
a. a $5 bill in your wallet
b. $100 in your checking account
c. $500 in your savings account
d. All of the above are included in M1.
22. Money
a. is more efficient than barter.
b. makes trades easier.
c. allows greater specialization.
d. All of the above are correct.
23. Paper money
a. has a high intrinsic value.
b. is the primary medium of exchange in a barter economy.
c. is valuable because it is generally accepted in trade.
d. is valuable only because of the legal tender requirement.
42. If an economy used gold as money, its money would be
a. commodity money, but not fiat money.
b. fiat money, but not commodity money.
c. both fiat and commodity money.
d. functioning as a store of value and as a unit of account, but not as a medium of exchange.
49. Which of the following is not included in M1?
 a. currency
b. demand deposits
c. savings deposits
d. travelers' checks
51. Which of the following is included in M2 but not in M1?
a. currency
b. demand deposits
c. savings deposits
d. All of the above are included in both M1 and M2.
62. Savings deposits are included in
a. M1 but not M2.
b. M2 but not M1.
c. M1 and M2.
d. neither M1 nor M2.
64. Which of the following is included in both M1 and M2?
a. currency
b. demand deposits
c. other checkable deposits
d. All of the above are correct.
65. Credit cards
a. defer payments.
b. are a store of value.
c. have led to wider use of currency.
d. are part of the money supply.
Table 29-1. The information in the table pertains to an imaginary economy.

Type of Money Amount

Large time deposits $80 billion
Small time deposits $75 billion
Demand deposits $75 billion
Other checkable deposits $40 billion
Savings deposits $10 billion
Travelers' checks $1 billion
Money market mutual funds $15 billion
Currency $110 billion
Credit card balances $10 billion
Miscellaneous categories of M2 $25 billion
70. Refer to Table 29-1. What is the M1 money supply?
a. $215 billion
b. $216 billion
c. $226 billion
d. $301 billion
71. Refer to Table 29-1. What is the M2 money supply?
a. $125 billion
b. $296 billion
c. $351 billion
d. $431 billion
72. Given the following information, what are the values of M1 and M2?

Small time deposits $650 billion

Demand deposits and other checkable deposits $300 billion
Savings deposits $750 billion
Money market mutual funds $600 billion
Travelers' checks $25 billion
Large time deposits $600 billion
Currency $100 billion
Miscellaneous categories in M2 $25 billion
 a. M1 = $400 billion, M2 = $2,475 billion.
b. M1 = $125 billion, M2 = $3,025 billion.
c. M1 = $425 billion, M2 = $2, 450 billion.
d. M1 = $425 billion, M2 = $1,875 billion.
76. If the central bank in some country lowered the reserve requirement, then the money multiplier for that
country
a. would increase.
b. would not change.
c. would decrease.
d. could do any of the above.
77. If the reserve ratio is 2.5 percent, then the money multiplier is
a. 40.
b. 25.
c. 2.5.
d. 1.25.
84. If R represents the reserve ratio for all banks in the economy, then the money multiplier is
a. 1/(1-R).
b. 1/R.
c. 1/(1+R).
d. (1+R)/R.
91. If the reserve ratio for all banks is 8 percent, then $4,500 of additional reserves can create up to
a. $4,500 of new money.
b. $48, 913 of new money.
c. $56,250 of new money.
d. $75,000 of new money.

Scenario 29-1.
The monetary policy of Salidiva is determined by the Salidivian Central Bank. The local currency is the salido.
Salidivian banks collectively hold 100 million salidos of required reserves, 25 million salidos of excess reserves,
250 million salidos of Salidivian Treasury Bonds, and their customers hold 1,000 million salidos of deposits.
Salidivians prefer to use only demand deposits and so the money supply consists of demand deposits.
99. Refer to Scenario 29-1. Assume that banks desire to continue holding the same ratio of excess reserves to
deposits. What is the reserve requirement and what is the reserve ratio?
a. 2 percent, 8 percent
b. 8 percent, 10 percent
c. 10 percent, 12.5 percent
d. None of the above is correct.
100. Refer to Scenario 29-1. Assuming the only other item Salidivian banks have on their balance sheets is loans,
what is the value of existing loans made by Salidivian banks?
a. 625 million salidos
b. 875 million salidos
c. 1,125 million salidos
d. None of the above is correct.
101. Refer to Scenario 29-1. Suppose the Central Bank of Salidiva loaned the banks of Salidiva 5 million salidos.
Suppose also that both the reserve requirement and the percentage of deposits held as excess reserves stay the
same. By how much would the money supply of Salidiva change?
a. 60 million salidos
b. 50 million salidos
c. 40 million salidos
d. None of the above is correct.
102. Refer to Scenario 29-1 . Suppose the Central Bank of Salidiva purchases 25 million salidos of Salidivian
Treasury Bonds from banks. Suppose also that both the reserve requirement and the percentage of deposits
held as excess reserves stay the same. By how much would the money supply of Salidiva change?
a. 200 million salidos
b. 150 million salidos
c. 100 million salidos
d. None of the above is correct.
Scenario 29-2.
The Monetary Policy of Tazi is controlled by the country’s central bank known as the Bank of Tazi. The local unit
of currency is the Taz. Aggregate banking statistics show that collectively the banks of Tazi hold 300 million Tazes
of required reserves, 75 million Tazes of excess reserves, have issued 7,500 million Tazes of deposits, and hold 225
million Tazes of Tazian Treasury bonds. Tazians prefer to use only demand deposits and so all money is on deposit
at the bank.
103. Refer to Scenario 29-2. Assume that banks desire to continue holding the same ratio of excess reserves to
deposits. What is the reserve requirement and the reserve ratio for Tazian Banks?
a. 5 percent, 8 percent
b. 4 percent, 8 percent
c. 4 percent, 5 percent
d. None of the above is correct.
104. Refer to Scenario 29-2. Assuming the only other thing Tazian banks have on their balance sheets is loans,
what is the value of existing loans made by Tazian banks?
a. 6,900 million Tazes
b. 7,125 million Tazes
c. 7,350 million Tazes
d. None of the above is correct.
105. Refer to Scenario 29-2. Suppose the Bank of Tazi loaned the banks of Tazi 10 million Tazes. Suppose also
that both the reserve requirement and the percentage of deposits held as excess reserves stay the same. By how
much would the money supply change?
a. 250 million Tazes
b. 200 million Tazes
c. 125 million Tazes
d. None of the above is correct.
106. Refer to Scenario 29-2. Suppose the Bank of Tazi purchased 50 million Tazes of Tazian Treasury Bonds from
the banks. Suppose also that both the reserve requirement and the percentage of deposits held as excess
reserves stay the same. By how much does the money supply change?
a. 625 million Tazes
b. 1,000 million Tazes
c. 1,250 million Tazes
d. None of the above is correct.
107. Refer to Scenario 29-2. Suppose that the Bank of Tazi changes the reserve requirement ratio to 3 percent.
Assuming that the banks still want to hold the same percentage of excess reserves what is the value of the
money supply after the change in the reserve requirement ratio?
a. 9,375 million Tazes
b. 10,000 million Tazes
c. 12,500 million Tazes
d. None of the above is correct to the nearest million salidos.
110. The money supply decreases if the Fed
a. sells Treasury bonds. The larger the reserve requirement, the larger the decrease will be.
b. sells Treasury bonds. The smaller the reserve requirement, the larger the decrease will be.
c. buys Treasury bonds. The larger the reserve requirement, the larger the decrease will be.
d. buys Treasury bonds. The smaller the reserve requirement, the larger the decrease will be.
111. The money supply increases when the Fed
a. lowers the discount rate. The increase will be larger the smaller the reserve ratio is.
b. lowers the discount rate. The increase will be larger the larger the reserve ratio is.
c. raises the discount rate. The increase will be larger the smaller the reserve ratio is.
d. raises the discount rate. The increase will be larger the larger the reserve ratio is.
112. If the Fed wanted to increase the money supply, it would make open market
a. purchases or lower the discount rate.
b. sales or lower the discount rate.
c. purchases or raise the discount rate.
d. sales or raise the discount rate.
114. To increase the money supply, the Fed could
a. sell government bonds.
b. decrease the discount rate.
c. increase the reserve requirement.
 d. None of the above is correct.
122. Which of the following lists two things that both decrease the money supply?
a. raise the discount rate, make open market purchases
b. raise the discount rate, make open market sales
c. lower the discount rate, make open market purchases
d. lower the discount rate, make open market sales
123. Which of the following lists two things that both decrease the money supply?
a. make open market purchases, raise the reserve requirement
b. make open market purchases, lower the reserve requirement
c. make open market sales, raise the reserve requirement
d. make open market sales, lower the reserve requirement
130. In a fractional-reserve banking system, an increase in reserve requirements
a. increases both the money multiplier and the money supply.
b. decreases both the money multiplier and the money supply.
c. increases the money multiplier, but decreases the money supply.
d. decreases the money multiplier, but increases the money supply.
136. If the reserve ratio is 15 percent, and banks do not hold excess reserves, and people hold only deposits and no
currency, then when the Fed sells $65 million of bonds to the public, bank reserves
a. increase by $65 million and the money supply eventually increases by $266.67 million.
b. increase by $65 million and the money supply eventually increases by $433.33 million.
c. decrease by $65 million and the money supply eventually decreases by $266.67 million.
d. decrease by $65 million and the money supply eventually decreases by $433.33 million.
138. The interest rate the Fed charges on loans it makes to banks is called
a. the prime rate.
b. the federal funds rate.
c. the discount rate.
d. the LIBOR.
139. The discount rate is
a. the interest rate the Fed charges banks.
b. one divided by the difference between one and the reserve ratio.
c. the interest rate banks receive on reserve deposits with the Fed.
d. the interest rate that banks charge on overnight loans to other banks.
140. The discount rate is
a. the rate at which public banks lend to other public banks.
b. the rate at which the Fed lends to banks.
c. the percentage difference between the face value of a Treasury bond and what the Fed pays for it.
d. the percentage of deposits banks hold as excess reserves.
146. The banking system currently has $10 billion of reserves, none of which are excess. People hold only deposits
and no currency, and the reserve requirement is 10 percent. If the Fed raises the reserve requirement to 20
percent and at the same time buys $1 billion of bonds, then by how much does the money supply change?
a. It falls by $45 billion.
b. It falls by $52 billion.
c. It falls by $55 billion.
d. None of the above is correct.
148. The banking system currently has $50 billion of reserves, none of which are excess. People hold only deposits
and no currency, and the reserve requirement is 10 percent. If the Fed raises the reserve requirement to 12.5
percent and at the same time sells $10 billion of bonds, then by how much does the money supply change?
a. It falls by $20 billion.
b. It falls by $110 billion.
c. It falls by $180 billion.
d. None of the above is correct.
151. If the public decides to hold less currency and more deposits in banks, bank reserves
a. decrease and the money supply eventually decreases.
b. decrease but the money supply does not change.
c. increase and the money supply eventually increases.
d. increase but the money supply does not change.
152. Suppose that in a country people gain more confidence in the banking system and so hold relatively less
currency and more deposits. As a result, bank reserves will
 a. decrease and the money supply will eventually decrease.
b. decrease and the money supply will eventually increase.
c. increase and the money supply will eventually decrease.
d. increase and the money supply will eventually increase.
154. During recessions, banks typically choose to hold more excess reserves relative to their deposits. This action
a. increases the money multiplier and increases the money supply.
b. decreases the money multiplier and decreases the money supply.
c. does not change the money multiplier, but increases the money supply.
d. does not change the money multiplier, but decreases the money supply.
160. If people decide to hold less currency relative to deposits, the money supply
a. falls. The Fed could lessen the impact of this by buying Treasury bonds.
b. falls. The Fed could lessen the impact of this by selling Treasury bonds.
c. rises. The Fed could lessen the impact of this by buying Treasury bonds.
d. rises. The Fed could lessen the impact of this by selling Treasury bonds.
161. Which of the following is correct?
a. The Fed can control the money supply precisely.
b. The amount of money in the economy does not depend on the behavior of depositors.
c. The amount of money in the economy depends in part on the behavior of banks.
d. None of the above is correct.
162. During wars the public tends to hold relatively more currency and relatively fewer deposits. This decision
makes reserves
a. and the money supply increase.
b. and the money supply decrease.
c. increase, but leaves the money supply unchanged.
d. decrease, but leaves the money supply unchanged.
166. The money supply decreases if
a. households decide to hold relatively more currency and relatively fewer deposits and banks decide
to hold relatively more excess reserves and make fewer loans.
b. households decide to hold relatively more currency and relatively fewer deposits and banks decide
to hold relatively fewer excess reserves and make more loans.
c. households decide to hold relatively less currency and relatively more deposits and banks decide to
hold relatively more excess reserves and make fewer loans.
d. households decide to hold relatively less currency and relatively more deposits and banks decide to
hold relatively less excess reserves and make more loans.
174. The federal funds rate is the
a. percentage of face value that the Federal Reserve is willing to pay for Treasury Securities.
b. percentage of deposits that banks must hold as reserves.
c. interest rate at which the Federal Reserve makes short-term loans to banks.
d. interest rate at which banks lend reserves to each other overnight.
175. The federal funds rate is the interest rate
a. the Federal Reserves charges for loans it makes to the federal government.
b. the Federal Reserve charges banks for short-term loans.
c. banks charge each other for short-term loans of reserves.
d. on newly issued one-year Treasury bonds.
182. A decrease in the money supply might indicate that the Fed had
a. purchased bonds in an attempt to increase the federal funds rate.
b. purchased bonds in an attempt to reduce the federal funds rate.
c. sold bonds in an attempt to increase the federal funds rate.
d. sold bonds in an attempt to reduce the federal funds rate.
186. When the Fed conducts open-market purchases,
a. it buys Treasury securities, which increases the money supply.
b. it buys Treasury securities, which decreases the money supply.
c. banks buy Treasury securities from Fed, which increases the money supply.
d. banks buy Treasury securities from the Fed, which decreases the money supply.