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Chapter 29

The Monetary System

Educators

BM

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

Kaylee M.
Numerade Educator

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.

BM
Ben M.
Numerade Educator

Problem 3

Your uncle repays a $\$$100 loan from Tenth National Bank (TNB) by writing a $\$$100 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.

Kaylee M.
Numerade Educator

Problem 4

Beleaguered State Bank (BSB) holds $\$$250 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 million in cash from her account. If
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 L.
Washington University in St Louis

Problem 5

You take $\$$100 you had kept under your mattress and deposit it in your bank account. If this $\$$100 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 L.
Washington University in St Louis

Problem 6

Happy Bank starts with $\$$200 in bank capital. It then accepts $\$$800 in deposits. It keeps 12.5 percent (1/8th) 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 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 L.
Washington University in St Louis

Problem 7

The Fed conducts a $\$$10 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.

Kaylee M.
Numerade Educator

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 worth of bonds or if someone deposits in a bank $\$$2,000 that she had been hiding in her cookie jar? If one creates more, how much more does it create? Support your thinking.

Yi Chun L.
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 million of government bonds, what is the effect on the economy's reserves and money supply?

b. Now suppose the Fed lowers the reserve requirement to 5 percent, but 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?

Yi Chun L.
Washington University in St Louis

Problem 10

Assume that the banking system has total reserves of $\$$100 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?

Kaylee M.
Numerade Educator

Problem 11

Assume that the reserve requirement is 20 percent. Also assume that banks do not hold excess reserves and there is no cash held by the public. The Fed decides that it wants to expand the money supply by $\$$40 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 L.
Washington University in St Louis

Problem 12

The economy of Elmendyn contains 2,000 $\$$1 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 L.
Washington University in St Louis