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Chapter 15 - Money Creation
REVIEW QUESTIONS
1. A goldsmith has $2 million of gold in his vaults. He issues $5 million in gold receipts. His gold
holdings are what fraction of the paper money (gold receipts) he has issued? LO1
a. 1/10.
b. 1/5.
c. 2/5.
d. 5/5.
Feedback: The goldsmith’s gold holdings are 2/5 of the value of the paper money that he
has issued because the ratio of gold holdings to paper money is $2 million in gold
holdings divided by $5 million in paper money, or 2/5. The goldsmith’s gold holdings are
2. A commercial bank has $100 million in checkable-deposit liabilities and $12 million in actual
reserves. The required reserve ratio is 10 percent. How big are the bank’s excess reserves? LO2
a. $100 million.
b. $88 million.
c. $12 million.
d. $2 million.
Feedback: This bank has $2 million of excess reserves. The bank’s excess reserves can
be calculated by subtracting the bank’s required reserves from the bank’s actual reserves
3. The actual reason that banks must hold required reserves is: LO2
a. To enhance liquidity and deter bank runs.
b. To help fund the Federal Deposit Insurance Corporation, which insures bank deposits.
c. To give the Fed control over the lending ability of commercial banks.
d. To help increase the number of bank loans.
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Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Chapter 15 - Money Creation
Feedback: By varying the required reserve ratio, the Fed can increase or decrease the
total volume of lending made by commercial banks. For example, a higher required
4. A single commercial bank in a multibank banking system can lend only an amount equal to its
initial preloan _________________. LO3
a. Total reserves.
b. Excess reserves.
c. Total deposits.
d. Excess deposits.
Feedback: A single commercial bank in a multibank banking system can lend only an
amount equal to its initial preloan excess reserves. This is true because when a bank
5. The two conflicting goals facing commercial banks are: LO3
a. Profit and liquidity.
b. Profit and loss.
c. Deposits and withdrawals.
d. Assets and liabilities.
Feedback: The two conflicting goals facing commercial banks are profit and liquidity.
On the one hand, commercial banks want to make profits. On the other hand, they need
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Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Chapter 15 - Money Creation
6. Suppose that the banking system in Canada has a required reserve ratio of 10 percent while the
banking system in the United States has a required reserve ratio of twenty percent. In which
country would $100 of initial excess reserves be able to cause a larger total amount of money
creation? LO4
a. Canada.
b. United States.
Feedback: A single dollar of initial excess reserves will be able to cause a larger total
amount of money creation in Canada. This is true because Canada has a lower required
reserve ratio. As a result, more money can be created by banks through the process of
multiple-deposit expansion. For instance, suppose we are looking at Canada and that the
initial $100 of excess reserves starts with Canada Bank A. Given the Canadian required
7. Suppose that the Fed has set the reserve ratio at 10 percent and that banks collectively have $2
billion in excess reserves. What is the maximum amount of new checkable-deposit money that
can be created by the banking system? LO5
a. $0.
b. $200 million.
c. $2 billion.
d. $20 billion.
Feedback: The correct answer is that the banking system can create a maximum of $20
billion in new checkable-deposit money. To see why this is true, begin with the fact that
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Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Chapter 15 - Money Creation
8. Suppose that last year $30 billion in new loans were extended by banks while $50 billion in old
loans were paid off by borrowers. What happened to the money supply? LO5
a. Increased.
b. Decreased.
c. Stayed the same.
Feedback: We know this to be true because last year the total dollar amount of loans
PROBLEMS
1. Suppose the assets of the Silver Lode Bank are $100,000 higher than on the previous day and
its net worth is up $20,000. By how much and in what direction must its liabilities have changed
from the day before? LO2
Feedback: By definition (balance sheet approach) the total amount of assets must equal
liabilities plus net worth.
2. Suppose that Serendipity Bank has excess reserves of $8,000 and checkable deposits of
$150,000. If the reserve ratio is 20 percent, what is the size of the bank’s actual reserves? LO2
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Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Chapter 15 - Money Creation
Feedback: The first step is to calculate the required reserves for the bank, which equals
the product of the required reserve ratio (decimal from) and checkable deposits.
The second step is to calculate actual reserves, which is the sum of required reserves and
excess reserves.
3. The Third National Bank has reserves of $20,000 and checkable deposits of $100,000. The
reserve ratio is 20 percent. Households deposit $5000 in currency into the bank and that currency
is added to reserves. What level of excess reserves does the bank now have? LO3
Feedback: The first step is to calculate checkable deposits. This equals the original
The second step is to calculate required reserves for the deposits, which equals the
product of the required reserve ratio (decimal from) and checkable deposits.
The third step is to calculate excess reserves, which equals actual reserves minus required
4. Suppose again that the Third National Bank has reserves of $20,000 and checkable deposits of
$100,000. The reserve ratio is 20 percent. The bank now sells $5,000 in securities to the Federal
Reserve Bank in its district, receiving a $5,000 increase in reserves in return. What level of
excess reserves does the bank now have? By what amount does your answer differ (yes, it does!)
from the answer to question 3? LO3
Feedback: The $5,000 sale of securities is directly transferred into the reserves of the
5. The balance sheet at the top of the next page is for Big Bucks Bank. The reserve ratio is 20
percent. LO3
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Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Chapter 15 - Money Creation
a. What is the maximum amount of new loans that Big Bucks Bank can make? Show in columns
1 and 1′ how the bank’s balance sheet will appear after the bank has lent this additional amount.
b. By how much has the supply of money changed?
c. How will the bank’s balance sheet appear after checks drawn for the entire amount of the new
loans have been cleared against the bank? Show the new balance sheet in columns 2 and 2′.
d. Answer questions a, b, and c on the assumption that the reserve ratio is 15 percent.
Answer: a. $2,000; Column (1): Reserves = $22,000; Securities = $38,000; Loans =
b. Increase in the money supply by $2,000
Feedback:
Part a:
The first step is to calculate required reserves, which equals the product of the required
The second step is to calculate excess reserves, which equals actual reserves minus
Assets
(1) (2)
Liabilities and net
worth
(1) (2)
Reserves
$22,00
$22,00
Checkable deposits
$102,000 _____
Chapter 15 - Money Creation
Assets
(1) (2)
Liabilities and net
worth
(1) (2)
Reserves
$22,00
$22,00
$20,000
Checkable deposits
$102,000 $100,000
Chapter 15 - Money Creation
Assets
(1) (2)
Liabilities and net
worth
(1) (2)
Reserves
$22,00
$22,00
$15,00
Checkable deposits
$107,000 $100,000
Chapter 15 - Money Creation
Assets
(1)
Liabilities and Net Worth
(2)
Reserves
$ 52
$52
Checkable
$200 $208
Two things to note here: (1) The banking system does not lose reserves (2) checkable
Part b:
We follow the same steps, but with a required reserve ratio of 20 percent.
The second step is to calculate excess reserves, which equals actual reserves minus
required reserves.
billion
The third step is to calculate the maximum amount the banking system (not a single bank
as in problem 5) might lend. This is found by taking product of the monetary multiplier
and the amount of excess reserves.
Assets
(1)
Liabilities and Net Worth
(2)
Reserves
$ 52
$52
Checkable
$200 $260
With the required reserve ratio of 20% (rather than 25%) the banking system can lend
7. If the required reserve ratio is 10 percent, what is the monetary multiplier? If the monetary
multiplier is 4, what is the required reserve ratio? LO5
Feedback:
The monetary multiplier equals one divided by the required reserve ratio.
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Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Chapter 15 - Money Creation
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Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
