Principles of Economics

Gregory Mankiw

Chapter 29

The Monetary System - all with Video Answers

Educators

Chapter Questions

Problem 1

Which of the following are considered money in the
U.S. economy? Which are not? Explain your answers by discussing each of the three functions of money.
a. a U.S. penny
b. a Mexican peso
c. a Picasso painting
d. a plastic credit card

Yi Chun Lin

Yi Chun Lin

Washington University in St Louis

Problem 2

Explain whether each of the following events increases or decreases the money supply.
a. The Fed buys bonds in open-market operations.
b. The Fed reduces the reserve requirement.
c. The Fed increases the interest rate it pays on reserves.
d. Citibank repays a loan it had previously taken from the Fed.
e. After a rash of pick pocketing, people decide to hold less currency.
f. Fearful of bank runs, bankers decide to hold more excess reserves.
g. The FOMC increases its target for the federal funds rate.

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 3

Your uncle repays a 100 dollar loan from Tenth National Bank (TNB) by writing a 100 dollar check from his TNB checking account. Use T-accounts to show the effect of this transaction on your uncle and on TNB. Has your uncle's wealth changed? Explain.

Yi Chun Lin

Washington University in St Louis

Problem 4

Beleaguered State Bank (BSB) holds 250 dollar million in deposits and maintains a reserve ratio of 10 percent.
a. Show a T-account for BSB.
b. Now suppose that BSB's largest depositor withdraws 10 dollar million in cash from her account and that BSB decides to restore its reserve ratio by reducing the amount of loans outstanding. Show its new T-account.
c. Explain what effect BSB's action will have on other banks.
d. Why might it be difficult for BSB to take the action described in part (b)? Discuss another way for BSB to return to its original reserve ratio.

Yi Chun Lin

Washington University in St Louis

Problem 5

You take 100 dollar you had kept under your mattress and deposit it in your bank account. If this 100 dollar stays in the banking system as reserves and if banks hold reserves equal to 10 percent of deposits, by how much does the total amount of deposits in the banking system increase? By how much does the money supply increase?

Yi Chun Lin

Washington University in St Louis

Problem 6

Happy Bank starts with 200 dollar in bank capital. It then accepts 800 dollar in deposits. It keeps 12.5 percent $(1 / 8$ th $)$ of deposits in reserve. It uses the rest of its assets to make bank loans.
a. Show the balance sheet of Happy Bank.
b. What is Happy Bank's leverage ratio?
c. Suppose that 10 percent of the borrowers from Happy Bank default and that these bank loans become worthless. Show the bank's new balance sheet.
d. By what percentage do the bank's total assets decline? By what percentage does the bank's capital decline? Which change is larger? Why?

Yi Chun Lin

Washington University in St Louis

Problem 7

The Fed conducts a 10 dollar million open-market purchase of government bonds. If the required reserve ratio is 10 percent, what are the largest and smallest possible increases in the money supply that could result? Explain.

Yi Chun Lin

Washington University in St Louis

Problem 8

Assume that the reserve requirement is 5 percent. All other things being equal, will the money supply expand more if the Fed buys 2,000 dollar worth of bonds or if someone deposits in a bank 2,000 dollar that she had been hiding in her cookie jar? If one of these actions creates more money than the other, how much more does it create? Support your thinking.

Yi Chun Lin

Washington University in St Louis

Problem 9

Suppose that the reserve requirement for checking deposits is 10 percent and that banks do not hold any excess reserves.
a. If the Fed sells 1 dollar million of government bonds, what is the effect on the economy's reserves and money supply?
b. Now suppose that the Fed lowers the reserve requirement to 5 percent but that banks choose to hold another 5 percent of deposits as excess reserves. Why might banks do so? What is the overall change in the money multiplier and the money supply as a result of these actions?

Jennifer Stoner

Jennifer Stoner

Numerade Educator

Problem 10

Assume that the banking system has total reserves of 100 dollar billion. Assume also that required reserves are 10 percent of checking deposits and that banks hold no excess reserves and households hold no
currency.
a. What is the money multiplier? What is the money supply?
b. If the Fed now raises required reserves to 20 percent of deposits, what are the change in reserves and the change in the money supply?

Yi Chun Lin

Washington University in St Louis

Problem 11

Assume that the reserve requirement is 20 percent. Also assume that banks do not hold excess reserves and that the public does not hold any cash. The Fed decides that it wants to expand the money supply by 40 dollar million.
a. If the Fed is using open-market operations, will it buy or sell bonds?
b. What quantity of bonds does the Fed need to buy or sell to accomplish the goal? Explain your reasoning.

Yi Chun Lin

Washington University in St Louis

Problem 12

The economy of Elmendyn contains 2,000 1 dollar bills.
a. If people hold all money as currency, what is the quantity of money?
b. If people hold all money as demand deposits and banks maintain 100 percent reserves, what is the quantity of money?
c. If people hold equal amounts of currency and demand deposits and banks maintain 100 percent reserves, what is the quantity of money?
d. If people hold all money as demand deposits and banks maintain a reserve ratio of 10 percent, what is the quantity of money?
e. If people hold equal amounts of currency and demand deposits and banks maintain a reserve ratio of 10 percent, what is the quantity of money?

Yi Chun Lin

Washington University in St Louis