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BANKING
Chapter 3 Study Guide
Money and Interest
True/False
 The flow of money has a direct effect on how the economy performs.
 Liquidity is variable, depending on the nature of the asset.
 M1 is sometimes referred to as the “base” money supply.
 The agreed-upon value of money in the United States today is based on the government’s
convention and has no necessary relationship to the value of gold, silver, bushels of grain,
feathers, or any other commodity.
 Banks can loan customers the money it has on deposit, minus the reserve requirement.
 A bank may use excess reserves to give depositors their money back if they demand it.
 Most large money transactions involve ledger entries rather than the movement of physical
currency.
 A dollar bill represents an obligation of the government of a guarantee to accept it for
payment of taxes and settlement of debts.
 When interest rates are high less credit is accessible and the economy slows down.
 The prime rate is usually the same among major banks.
Multiple Choice
 If there is too much money moving in the economy prices may rise, causing inflation.
 The money in your wallet would be considered the most liquid asset.
 The money movement measurement of M1 is money that can be spent immediately.
 The official currency of the United States can properly be classified as fiat money.
 The Federal Reserve’s supply and control of money, banks’ use of money, and the demand for
money are all factors in money creation.
 Securities the bank has purchased from the Federal government are considered a secondary
reserve.
 Money on deposit, minus the reserve requirement, can be loaned by banks to customers.
 If banks must hold more money in reserve, there is less money available to lend.
 The interest rate the Federal Reserve charges for loans to member banks is called the
discount rate.
 The Federal Reserve influences the federal funds rate by buying and selling government
securities.
Completion
 The money supply is defined as the liquid assets held by banks and individuals.
 The measure of how quickly things may be converted to something of value is called
liquidity.
 Commodity money is based on some item of value, such as gold or precious stones.
 Fiat money is money that is deemed legal tender by a government.
 The multiplier effect is a phenomenon that creates new deposits from lending.
 The federal funds rate is the amount of interest charged for short-term, interbank loans.
 The discount rate is the interest rate the Federal Reserve sets and charges for loans to
member banks.
Short Answer
1. What types of money and circumstances of liquidity are defined by the M2 element of the
money supply?
2. Why does the Federal Reserve require banks to hold money in reserve?
3. What happens to the money supply if the Fed lowers reserve requirements? Why?
4. What is the prime rate?
Essay
1. Why might extra money in the economy cause inflation?
2. What is a fractional-reserve system? What is its relationship to the money supply in the
United States?
3. Name the three types of reserves held by banks.