Chapter 14
ANSWERS TO QUESTIONS
holdings of currency do not change.
1. Classify each of these transactions as an asset, a liability, or neither for each of the
“players” in the money supply process—the federal reserve, banks, and depositors.
a. You get a $10,000 loan from the bank to buy an automobile.
b. You deposit $400 into your checking account at the local bank.
c. The Fed provides an emergency loan to a bank for $1,000,000.
e. You use your debit card to purchase a meal at a restaurant for $100.
2. The First National Bank receives an extra $100 of reserves but decides not to lend out any of
these reserves. How much deposit creation takes place for the entire banking system?
3. Suppose the Fed buys $1 million of bonds from the First National Bank. If the First National
Bank and all other banks use the resulting increase in reserves to purchase securities only
and not to make loans, what will happen to checkable deposits?
4. If a bank depositor withdraws $1,000 of currency from an account, what happens to
reserves, checkable deposits, and the monetary base?
5. If a bank sells $10 million of bonds to the Fed to pay back $10 million on the loan it owes,
what is the effect on the level of checkable deposits?
6. If you decide to hold $100 less cash than usual and therefore deposit $100 more cash in the
bank, what effect will this have on checkable deposits in the banking system if the rest of the
public keeps its holdings of currency constant?
7. “The Fed can perfectly control the amount of reserves in the system.” Is this statement true,
false, or uncertain? Explain.
8. “The Fed can perfectly control the amount of the monetary base, but has less control over the
composition of the monetary base.” Is this statement true, false, or uncertain? Explain.
9. The Fed buys $100 million of bonds from the public and also lowers the required reserve
ratio. What will happen to the money supply?
10. Describe how each of the following can affect the money supply: (a) the central bank; (b)
banks; and (c) depositors.
11. “The money multiplier is necessarily greater than 1.” Is this statement true, false, or
uncertain? Explain your answer.
12. What effect might a financial panic have on the money multiplier and the money supply?
Why?
13. During the Great Depression years from 1930–1933, both the currency ratio c and the
excess reserves ratio e rose dramatically. What effect did these factors have on the money
multiplier?
14. In October 2008, the Federal Reserve began paying interest on the amount of excess reserves
held by banks. How, if at all, might this affect the multiplier process and the money supply?
15. The money multiplier declined significantly during the period 1930–1933 and also during the
recent financial crisis of 2008–2010. Yet the M1 money supply decreased by 25% in the
Depression period but increased by more than 20% during the recent financial crisis. What
explains the difference in outcomes?
ANSWERS TO APPLIED PROBLEMS
16. If the Fed sells $2 million of bonds to the First National Bank, what happens to reserves and
the monetary base? Use T-accounts to explain your answer.
First National Bank
Assets
Liabilities
Reserves
Securities
Federal Reserve System
Assets
Liabilities
Securities
Reserves
17. If the Fed sells $2 million of bonds to Irving the Investor, who pays for the bonds with a
briefcase filled with currency, what happens to reserves and the monetary base? Use T-
accounts to explain your answer.
Reserves are unchanged, but the monetary base decreases by $2 million due to the currency
reduction, as the following T-accounts show:
Irving the Investor
Assets
Liabilities
Currency
Securities
Federal Reserve System
Assets
Liabilities
Securities
Currency
18. If the Fed lends five banks a total of $100 million but depositors withdraw $50 million and
hold it as currency, what happens to reserves and the monetary base? Use T-accounts to
explain your answer.
Banking System (all five banks)
Assets
Reserves
Federal Reserve System
Assets
Liabilities
Loans (borrowings from the Fed)
million
Reserves
Public
Assets
Liabilities
No change
No change