978-0077660772 Chapter 15 Solution Manual Part 2

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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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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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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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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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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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

Checkable deposits

$102,000 _____

Chapter 15 – Money Creation

Assets

(1) (2)

Liabilities and net

worth

(1) (2)

Reserves

$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

$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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Chapter 15 – Money Creation

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