RELATED CONCEPTS: | CHECKABLE DEPOSITS| COMMODITY MONEY| DISCOUNT RATE| DOUBLE COINCIDENCE OF WANTS| EXCESS RESERVES| FLAT MONEY| LIQUIDITY| M1| M2| MONETARY BASE| MONEY| OPEN MARKET OPERATION| REQUIRED RESERVE RATIO (R)|
In a barter economy, how would an economics professor survive?
- The professor would have to find students that wanted economic lessons and had something the professor wanted (such as food, housing, and clothing). Obviously, there aren’t too many professors of economics in barter economies. Indeed, there is very little specialization in barter economies, since most people produce only goods that are in common demand.
Assume the required reserve ration is 20%.
a. If a single bank in the banking system has $10 million in excess reserves, how much new money, at most, could it create by itselft?
b. If the whole banking system has $10 million in excess reserves, how much new money, at most, could it create?
b. $40 million (5 x $8 million)
Indicate whether the following events will increase or decrease the money supply:
Event A : The Fed buys government securities from the public.
Event B : Banks decide to hold more excess reserves.
Event C : The public wants less cash because of an increased fear of being robbed.
Event D : The Fed raises the discount rate.
Event E : The Fed prints more currency.
Event F : Interest rates rise.
Event A : Increase.
Event B : Decrease (smaller multiplier).
Event C : Increase (larger multiplier because more of the money lent will be redeposited).
Event D : Decrease (reduces the base when banks borrow less from the Fed).
Event E : Increase.
Event F : Increase (banks hold smaller excess reserves when they can make more on them by lending them out: This increases the multiplier).
Jane withdraws $1,000 from her checking account and puts it in a cookie jar. How much, at most, could the money supply fall if the required reserve ration is 10%?
- $9,000 (checking deposits will fall $10,000 but currency held by the public will go up $1,000)
During Christmas time, the public’s demand for cash goes up. How should the Fed react to this if it wants to keep the money supply constant? What will happen to the monetary base and the money multiplier?
- The increased demand for cash reduces the actual multiplier (because less lent money is redeposited). So the Fed must increase the monetary base. Typically, it does this by buying government securities.
If the public suddenly wanted to hold all its money in the form of cash (withdrawing all its money from checking and savings accounts), what would happen to the money supply?
- The money supply would shrink back down to the size of the monetary base.
If banks could not find anyone willing to borrow funds at the interest rate they charge, what would happen to the money supply?
- The money supply would shrink, because banks could not lend and relend.
One of the liabilities of the Federal Reserve is Federal Reserve notes (the dollar bill is an example). Since this is a liability, what does the Fed “owe” the public or banks that hold these dollars?
- Our currency is a flat currency. The Fed really doesn’t owe anything.
How can the public cause the money supply to shrink?
- By holding more in cash and less in checking and savings accounts.
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