Money and Central Banks
1. The U.S. government owns about 4,500 tons of gold, stored mainly at Fort Knox
in Kentucky. Why did the government accumulate this gold? Should it continue to
hold the gold, or sell it?
ANSWER: The accumulation of gold by the U.S. government is related to the history
of the U.S. dollar. The experiment of issuing fiat money, the Continental dollar, failed
early in U.S. history. For almost 200 years, ending in the early 1970s, the U.S. gov-
ernment chose to issue money that was tied to gold in some fashion. With such a gold
standard, a country is required to exchange paper money for units of gold held by the
2. In the 1964 movie Goldfinger, the title character schemes to increase the price of
gold. He plans to drop an atomic bomb on Fort Knox, making the gold there ra-
dioactive. His operation is financed by North Korea, which hopes to make the dollar
worthless, disrupting the U.S. economy. If James Bond hadn’t thwarted Goldfinger’s
plan, what effects might it have had on the monetary system and economy in 1964?
ANSWER: Recall that in 1964 private citizens were not allowed to hold gold, except
to make jewelry. Only foreign governments were allowed to exchange dollars for gold.
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3. Scientists believe that the Sun will explode some billions of years from now. Ac-
cording to some economic theorists, this means that nobody should accept money
today. What is the logic behind this idea?
ANSWER: The United States today uses fiat money, pieces of paper that are not
backed by any commodity. Fiat money is only valuable when the holders of money
today believe that this money will be accepted as a medium of exchange tomorrow.
4. The U.S. population is approximately 300 million. Using the information in Table
2.1, calculate the average amount of U.S. currency per citizen. Do most Americans
hold that much cash? If not, where is it?
ANSWER: The total amount of currency in May 2010 was $882,000 million. For a
U.S. population of 300 million people this amounts to an average currency holding of
5. Suppose that technology completely eliminates the use of cash. People buy news-
papers by putting debit cards in the newspaper box. They use the Internet to pay
babysitters. With no cash, does the nature of money change? Should the Federal
Reserve change the definition of M1?
ANSWER: M1 is one measure of a monetary aggregate, summing mostly the amount
of currency and checking deposits (traveler’s checks are already negligible and will
go the way of dinosaurs in the near future). If the use of cash were completely elim-
6. Explain how each of these events affects the amount of M1 that people hold.
a. ATMs are invented.
ANSWER: The ATM (automatic teller machine) now gives you 24-hour access to
your checking account, whereas before you had to go to a live person in a bank
branch during regular business hours to make a withdrawal. This will probably change
the amount of cash you carry in your wallet. There is no need for large cash balances
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b. Credit cards are invented.
ANSWER: Using a credit card to make a purchase means that you borrow until you
pay off the credit card bill. You will have to transfer checking deposits to your credit
card company to pay your credit card bill. Instead of accessing your checking de-
c. Debit cards are invented.
ANSWER: The use of debit cards for payment means that your checking deposit is
d. Stored-value cards are invented.
ANSWER: A stored-value card can be thought of as a prepaid debit card. In that
sense, the stored-value card becomes an alternative to holding checking deposits.
e. Interest rates on bonds rise.
ANSWER: If interest rates on bonds rise, it becomes more costly to hold cash and
checking deposits, both of which are assets that are generally non-interest-bearing.
7. Is your checking account a sweep account? Find out from your bank. How much
of the money you deposit is actually in the account on a typical day, and how much
has been swept into an MMDA?
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8. Recall the transactions that are triggered when you pay your rent (see Figure 2.2).
Now suppose your check bounces because you don’t have enough funds in your ac-
count. How does this change the series of transactions?
ANSWER: When you pay your rent by check, then your landlord Julia does not re-
ceive the payment until your check has been submitted to your bank and your bank
9. For a citizen of the United States, how liquid is each of the following assets? Ex-
plain each answer.
a. Bonds issued by the U.S. government.
ANSWER: You can find daily information on government bonds in the financial pages
b. Bonds issued by corporations.
ANSWER: Bonds issued by corporations can also be traded in a daily market, but the
quality of those types of bonds varies depending on which corporation has issued
c. Postimpressionist paintings.
ANSWER: There is a market for Postimpressionist paintings, but this market is harder
to access and understand than the well-organized bond markets. Fewer buyers are
d. British pounds.
ANSWER: Like the U.S. dollar, the British pound is a major currency, easily ex-
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ONLINE AND DATA QUESTIONS
www.worthpublishers.com/ball2
10. Using the data on the text Web site, compute the ratio of M1 to GDP and the ratio
of M2 to GDP. These ratios show how much money people hold relative to total
spending in the economy. Plot these ratios over the last 40 years. Have the ratios
been steady, or have they risen or fallen? What might explain these trends?
ANSWER: The ratio of M1/GDP has been falling relatively steadily over the last 40
years, while the ratio of M2/GDP has been mostly constant over the same time pe-
11. Figure 2.4 shows that sweep programs have reduced the level of M1. How do you
think sweeps have affected M2? Do the M2 data on the text Web site support your
answer?
ANSWER: Sweep programs transfer funds from checking accounts to money-
market deposit accounts (MMDA). Since checking account balances and MMDAs
12. Link through the text Web site to the 2010 Federal Reserve Payments Study.
From 2006 to 2009, did the shift to electronic payment shown in Figure 2.1 slow down,
continue at the same pace, or speed up? Explain why.
13. The text Web site has links to several sites with information about stored-value
cards. Some are maintained by card issuers, others by government agencies or con-
sumer advocates. After visiting some of these sites, discuss the pros and cons of
multipurpose stored-value cards. Who, if anybody, would be wise to use them?
ANSWER: Stored-value cards are cards with a magnetic strip on the back or
equipped with a microchip; they hold information about money that has been prepaid
into an account for the purpose of making payments. These cards are neither credit
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