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Explain what we mean by “money”, and taking a “narrow” definition of this measure, how a fractional reserve banking system can take a $1000 of “high-powered” money – like cash – and expand the overall money supply by some multiple of that amount; and why can this “money multiplier” be at times quite unpredictable?

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Chika Ilonah
Chika IlonahLv10
28 Sep 2019

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Related questions

6. The purpose of this exercise is to illustrate the multiple expansion of bank deposits in a fractional- reserve banking system. Assume the Fed’s legal reserve requirement is 10%

(Formula)

1. a. Required reserves = Required reserve ratio ´ checkable deposits

b. Actual reserves = Required reserves + excess reserves

The consolidated balance sheet of the U.S. banking system indicates:

Assets Liabilities

Reserves $40,000 Checkable deposits $100,000

a. The simple money multiplier equals _______________. Formula:

b. The banking system has excess reserves of $_______________.

Formula (write out formula #1a):

Formula (write out formula #1b):

c. Loans and the money supply can be expanded by a maximum of $_______________.

Assume that banks do not hold excess reserves and that households do not hold currency, so the only form of money is demand deposits. To simplify the analysis, suppose the banking system has total reserves of $400. Determine the money multiplier and the money supply for each reserve requirement listed in the following table.

Reserve Requirement Simple Money Multiplier Money Supply
(Percent) (Dollars)
20    
10    

A higher reserve requirement is associated with a money supply.

Suppose the Federal Reserve wants to increase the money supply by $200. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to worth of U.S. government bonds.

Now, suppose that, rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. Specifically, banks increase the percentage of deposits held as reserves from 10% to 25%. This increase in the reserve ratio causes the money multiplier to to . Under these conditions, the Fed would need to worth of U.S. government bonds in order to increase the money supply by $200.

Which of the following statements help to explain why, in the real world, the Fed cannot precisely control the money supply? Check all that apply.

  1. The Fed cannot control the amount of money that households choose to hold as currency.
  2. The Fed cannot prevent banks from lending out required reserves.
  3. The Fed cannot control whether and to what extent banks hold excess reserves.

1.  The Federal Funds Rate is set by the Federal Reserve on the first business day of each month by faxing the rate to the member banks of each Federal Reserve District.

A. True

B. False

 

2. The Federal Reserve is a single Central bank located on Wall Street in New York City.

A. True

B. False

 

3. Which of the following is NOT true about the Federal Reserve System?

A. Terms of service of the members of the Board of Governors are longer than the number of years that a two-term President of the United States would serve.

B. The Federal Reserve System is the nation's central bank and is comprised of 12 Federal Reserve Banks that serve as bankers' banks.

C. Some of the main functions of the Federal Reserve System include the authority to control the money supply, to issue currency, to set reserve requirements, and to hold reserves.

D. While Congress controls the actions of the Federal Reserve, the President has the authority to appoint and remove private banks from the Federal Reserve System.

 

4. Which of the following is NOT true about restrictive monetary policy?

A. A restrictive monetary policy seeks to raise the federal funds rate.

B. A restrictive monetary policy seeks to expand the money supply.

C. A restrictive monetary policy seeks to raise the Federal Funds Rate by selling government bonds or raising the reserve requirement ratio or increasing the discount rate.

D. A restrictive monetary policy is used when the government is concerned about suddenly increasing inflation.

 

5. Which of the following statements is NOT true about contractionary fiscal policy?

A. Contractionary fiscal policy consists of reductions in government spending or increases in taxes.

B. Contractionary fiscal policy can include both reductions in government spending or increases in taxes.

C. Contractionary fiscal policy seeks to shift the Aggregate Demand curve to the right.

D. Contractionary fiscal policy is used when the government seeks to reduce suddenly surging inflation.

 

6. The Federal Reserve creates money by printing the amount of desired new money and distributing it via armored trucks and high-security railways to Federal Reserve District Banks.

A. True

B. False

 

7. If the Fed feared a looming recession was just around the corner, which of the following actions would it "NOT" consider?

A. The Fed would raise the discount rate.

B. In order to influence prevailing commercial interest rates to fall, the Fed would buy large amounts of government securities.

C. In order to expand the money supply (which influences prevailing commercial interest rates to fall), the Fed would either buy large volumes of government bonds, lower the reserve requirement or cut the discount rate.

D. The Fed would seek to expand the money supply because, in so doing, the federal funds rate would fall and that would stimulate commercial interest rates to fall.

 

8. Which of the following statements is NOT true about the ability of the Federal Reserve System to expand the money supply?

A. The Federal Reserve System uses the fractional nature of the banking system to create money in order to expand the money supply.

B. The money multiplier defines the relationship between new excess reserves throughout the banking system and the creation of money by banks in the system. It is calculated by dividing the number 1 by the Required Reserve Ratio. [1/rr].

C. If the required reserve ratio is 20%, then $80 billion in new excess reserves will create $400 billion in bank system lending throughout the entire banking system.

D. If the reserve requirement is 100%, then the banks can generate 100% in new excess reserves.

 

9. Which of the following is NOT true about the tools of monetary policy?

A. The Fed can alter the money supply through open market operations, changes in the reserve ratio or adjustments to the discount rate.

B. Lowering the reserve ratio would expand the money supply.

C. Raising the discount rate would restrict the money supply.

D. Adjusting the reserve requirement is the most important day-to-day method for controlling the nation's money supply.

 

10. If the Federal Reserve wishes to hold off a feared recession, it will sell large volumes of government bonds.

A. True

B. False

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