Chapter 25:
1. Explain the difficulties that an economics professor might face in purchasing a new car under a barter
system.
Answer: An economics professor may find it difficult to locate a trading partner willing to
2. Why do people who live in countries experiencing rapid inflation often prefer to hold American dollars
Answer: Domestic currencies lose their purchasing power quickly in countries
that, in choosing between different currencies to transact in, good money drives out bad money?
be treated as having the same official value, even though they had different amounts of precious
4. Which one of each of the following pairs of assets is most liquid?
a. a traveler’s check
5. Indicate whether each of the following belongs on th
a. loans the asset side of a bank’s balance sheet
6. Why do you think asking whether money is an asset of liability is a trick question in economics?
7. Why have ATMs and online banking made savings accounts more liquid than they used to be?
Answer: ATMs and online banking have made it far easier to convert savings accounts
8. Why would the increasing liquidity of savings accounts make some monetary economists track the size
of M1 plus savings account balances (called MZM) over time?
Answer: Since, as question 7 shows, savings accounts are far more liquid than before, it
9. What would each of the following changes do to M1 and M2?
Change M1 M2
An increase in currency in circulation increase increase
A conversion of checking account balances into money market mutual
10. Given that the Fed currently imposes reserve requirements on checking deposits, but not on savings
deposits, why would banks prefer to hold deposits as savings accounts rather than checking accounts,
other things equal?
Answer: Since the Fed does not currently require reserves to be set aside earning almost
11. Since the Fed has begun paying interest on bank reserves at the Fed, do banks still want to avoid
holding excess reserves?
Answer: If lending was more profitable than the currently very low interest rate (formerly
12. What would the money multiplier be if the required reserve ratio were
13. Assume there was a new $100,000 deposit into a checking account at a bank.
a. What would be the resulting excess reserves created by that deposit if banks faced a reserve
requirement of
10 percent? $90,000
b. How many additional dollars could that bank lend out as a result of that deposit if banks faced a
reserve requirement of
10 percent? $90,000
c. How many additional dollars of money could the banking system as a whole create in response to such
a new deposit if banks faced a reserve requirement of
10 percent? $1,000,000
14. If the required reserve ratio is 10 percent, calculate the potential change in demand deposits under
the following circumstances:
a. You take $5,000 from under your mattress and deposit it in your bank.
b. You withdraw $50 from the bank and leave it in your wallet for emergencies.
c. You write a check for $2,500 drawn on your bank (Wells Fargo) to an auto mechanic who deposits the
funds in his bank (Bank of America).
Answer: While the balance sheets of the individual banks are affected, there is no change
15. Calculate the magnitude of the money multiplier if banks were to hold 100 percent of deposits in
reserve. Would banks be able to create money in such a case? Explain.
Answer: The value of the money multiplier would equal one. Banks would not be able to
16. Answer the following questions.
a. If a bank had reserves of $30,000 and demand deposits of $200,000 (and no other deposits), how
much could it lend out if it faced a required reserve ratio of
10 percent? $10,000
b. If the
could it now lend out if it faced a required reserve ratio of
10 percent? $46,000