Download How Banks Create Money

Money, Banking
&
Monetary policy
Topics covered : Money & Banking
How Banks Create Money
Monetary Policy
True or false :
1) When you use money to purchase groceries, money is functioning as a store of
value.
2) The M1 money supply is composed of currency, checkable deposits, and time
deposits.
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3) The value of money varies inversely with the price level.
4) The transactions demand for money will decrease when aggregate income
decreases.
5) The asset demand for money varies directly with the interest rate.
6) Bond prices and interest rates are directly related.
7) When a borrower repays a loan of kd 4000, either in cash or by check, the supply
of money is reduced by kd 4000.
8) Commercial banks create money in the form of checkable deposits when they
make loans.
9) Maximum checkable-deposit expansion is equal to the amount of actual reserves
multiplied by the monetary multiplier.
10) The monetary multiplier is excess reserves multiplied by required reserves.
11) If a commercial banking system has kd 200,000 of outstanding checkable
deposits and actual reserves of kd 70,000, then with a reserve ratio of 20 percent the
banking system can expand the supply of money by a maximum of kd 180,000.
12) Aggregate demand tends to be increased when the Central bank sells government
securities in the open market.
13) If the monetary authority wished to follow a tight money policy, it would buy
government securities in the open market.
14) The most effective and most-often used tool of monetary policy is the openmarket operation, in which government securities are bought and sold.
15) An easy money policy is designed to correct a problem of high unemployment
and sluggish economic growth.
16) The major advantages of monetary policy include its flexibility, speed, and
political acceptability.
Multiple choice :
(1) The functions of money are to serve as a :
A)
resource allocator, method for accounting, and means of income
distribution .
B)
unit of account, store of value, and medium of exchange .
C)
determinant of consumption, investment, and government spending .
D)
factor of production, exchange, and aggregate supply.
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(2) The smallest component of the money supply (M1) is :
A)
currency .
B)
checkable deposits .
C)
small time deposits .
D)
large time deposits.
(3) Which definition(s) of the money supply include(s) only items which are directly
and immediately usable as a medium of exchange ?
A)
M1
B)
M2
C)
M3
D)
M1 and M2
(4) Ahmed deposits kd 200 in currency in his checking account at a bank. This
deposit is treated as :
A)
a subtraction of kd 200 from the money supply because the kd 200 in
currency is no longer in circulation .
B)
an addition of kd 200 to the money supply because of the creation of a
checkable deposit of kd 200 .
C)
an addition of kd 200 to the money supply because the bank holds kd
200 in currency and the checking account has been increased by kd 200 .
D)
no change in the money supply because the kd 200 in currency has
been converted to a kd 200 increase in checkable deposits.
(5) Checkable deposits are money because they are :
A)
legal tender .
B)
fiat money .
C)
acceptable in exchange .
D)
token money.
(6) If the value of the dinar is falling, then it follows that :
A)
the price index is falling .
B)
the price index is rising .
C)
real incomes are falling .
D)
interest rates are rising.
(7) To keep high inflation from eroding the value of money, monetary authorities:
A)
create token money that is less than its intrinsic value.
B)
make paper money legal tender for the payment of debt.
C)
establish insurance on checkable deposit accounts.
D)
control the supply of money in the economy.
The table below shows the money supply for the Kuwaiti economy for the month of
April 2004 (Millions of Dinars).
Items
Millions of
Dinars
1 Checkable deposits (Demand Deposits) 2409
2 Currency
532
3 Quasi-Money
8230
4
4 Deposits with Financial Institutions
8.6
(8) The size of the M1 money supply is:
A)
2949.6
B)
2941
C)
2125
D)
8230
(9) The size of the M2 money supply is:
A)
10,639
B)
8230
C)
11,171
D)
8.6
(10) The size of the M3 money supply is:
A)
11,711.6
B)
8.6
C)
11,179.6
D)
10,639
(11) Sarah transfers kd 4,000 from her savings account to her checking account.
What effect is this change likely to have on M1, M2, and M3 ?
A)
M1 decreases, M2 increases, and M3 stays the same .
B)
M1 increases, M2 decreases, and M3 stays the same .
C)
M1 increases, M2 stays the same, and M3 decreases .
D)
M1 increases, and M2 and M3 stay the same.
(12) The transactions demand for money will shift to the :
A)
left when nominal GDP increases .
B)
left when nominal GDP decreases .
C)
right when nominal GDP decreases .
D)
right when the interest rate increases.
(13) A consumer holds money to meet spending needs. This would be an example of
the :
A)
use of money as a measure of value .
B)
use of money as legal tender .
C)
transactions demand for money .
D)
asset demand for money.
(14) A decrease in the interest rate will cause a(n) :
A)
increase in the transactions demand for money .
B)
decrease in the transactions demand for money .
C)
decrease in the amount of money held as an asset .
D)
increase in the amount of money held as an asset.
(15) The total quantity of money demanded is determined by:
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A)
subtracting the asset demand for money from the transactions demand
for money.
B)
adding the transactions demand for money to the asset demand for
money.
C)
subtracting the transactions demand for money from nominal GDP.
D)
adding the asset demand for money to nominal GDP.
(16) An increase in nominal GDP will :
A)
increase the transactions demand and total demand for money .
B)
decrease the transactions demand and total demand for money .
C)
increase the transactions demand for money but decrease the total
demand for money .
D)
decrease the transactions demand for money but increase the total
demand for money.
(17) If interest rates rise, there will be a(n) :
A)
increase in the total amount of money demanded .
B)
decrease in the total amount of money demanded .
C)
decrease in the total amount of money supplied .
D)
increase in the asset demand for money.
(18) The interest rate will fall when the :
A)
quantity of money demanded exceeds the quantity of money supplied .
B)
quantity of money supplied exceeds the quantity of money demanded .
C)
demand for money increases .
D)
supply of money decreases.
(19) Bond prices and interest rates are :
A)
directly related .
B)
positively related .
C)
negatively related .
D)
unrelated.
(20) The reserve ratio is equal to:
A)
a commercial bank's checkable-deposit liabilities divided by its
required reserves.
B)
a commercial bank's required reserves divided by its checkable-deposit
liabilities.
C)
a commercial bank's checkable-deposit liabilities multiplied by its
excess reserves.
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D)
a commercial bank's excess reserves divided by its required reserves.
(21) A commercial bank has checkable-deposit liabilities of kd 50,000 and a reserve
ratio of 20 percent. What is the amount of required reserves?
A)
kd 10,000
B)
kd 50,000
C)
kd 250,000
D)
kd 1 million
(22) A commercial bank has actual reserves of kd 1 million and checkable-deposit
liabilities of kd 9 million, and the required reserve ratio is 10 percent. The excess
reserves of the bank are:
A)
kd 50,000
B)
kd 100,000
C)
kd 900,000
D)
kd 1 million
(23) A bank is in the position to make loans when required reserves :
A)
equal actual reserves .
B)
equal excess reserves .
C)
are less than actual reserves .
D)
are greater than actual reserves.
(24) An individual deposits kd 12,000 in a commercial bank. The bank is required to
hold 10 percent of all deposits on reserve at the central bank. The deposit increases
the loan capacity of the bank by :
A)
kd 11,000
B)
kd 10,800
C)
kd 9,600
D)
kd 6,000
(25) Suppose the Wafraa Bank has excess reserves of kd 12,000 and outstanding
checkable deposits of kd 125,000. If the reserve requirement is 20 percent, what are
the bank's actual reserves ?
A)
kd 25,000
B)
kd 37,000
C)
kd 44,000
D)
kd 47,000
(26) Citizen A deposits kd 2,000 in currency in the First Arab Bank. Later that same
day Citizen B negotiates a loan for kd 5,400 at the same bank. After these
transactions, the supply of money has :
A)
increased by kd 2,100 .
B)
increased by kd 3,300 .
C)
increased by kd 5,400 .
D)
decreased by kd 3,300.
(27) Other things being equal, an expansion of commercial bank lending :
A)
changes the composition, but not the size, of the money supply .
B)
is desirable during a period of demand-pull inflation .
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C)
D)
reduces the money supply .
increases the money supply.
(28) A single commercial bank must meet a 25 percent reserve requirement. If it
initially has no excess reserves and then kd 2,000 in cash is deposited in the bank, it
can increase its loans by a maximum of :
A)
kd 2,000
B)
kd 1,500
C)
kd 1,250
D)
kd 1,000
(29) If the Central bank System sells kd 5 billion of government securities to the
commercial banking system, the deposit reserves of commercial banks would :
A)
increase by kd 5 billion .
B)
decrease by kd 5 billion .
C)
be added to net worth .
D)
remain the same.
(30) Assume the commercial banking system has excess reserves of kd 5,000 and can
make new loans of kd 35,000 and just meet its legal reserve requirements. The
required reserve ratio must be about :
A)
7 percent .
B)
41 percent .
C)
02 percent .
D)
02 percent.
(31) The multiple by which the commercial banking system can expand the supply of
money is equal to :
A)
its excess reserves .
B)
the reciprocal of the discount rate .
C)
the reciprocal of the reserve ratio .
D)
the ratio of fixed to liquid assets.
(32) Assume that the legally required reserve is 15 percent and commercial banks
choose to hold additional excess reserves equal to 5 percent of any newly acquired
deposits. Under these circumstances the monetary multiplier for the commercial
banking system is:
A)
6.67
B)
5
C)
4
D)
3
8
(33) A commercial bank has checkable-deposit liabilities of kd 500,000, reserves of
kd 150,000, and a required reserve ratio of 20 percent. The amount by which a single
commercial bank and the amount by which the banking system can increase loans are
respectively,:
A)
kd 020222 and kd 150,000.
B)
kd 020222 and kd 250,000.
C)
kd 020222 and kd 500,000.
D)
kd 100,000 and kd 500,000.
(34) The commercial banking system has excess reserves of kd 200,000, makes new
loans of kd 800,000, and is just meeting its reserve requirements. The required
reserve ratio is:
A)
42 percent.
B)
02 percent.
C)
00 percent.
D)
02 percent.
(35) When bankers hold excess reserves:
A)
the size of the monetary multiplier increases.
B)
the money-creating potential of the banking system increases.
C)
the money-creating potential of the banking system decreases.
D)
there is no change in the money-creating potential of the banking
system.
(36) The fundamental objective of monetary policy is to assist the economy in
achieving:
A)
a rapid pace of economic growth.
B)
a money supply which is based on the gold standard.
C)
a full-employment, noninflationary level of total output.
D)
a balanced-budget consistent with full-employment.
(37) The Central bank of Kuwait can increase commercial bank reserves by :
A)
increasing the discount rate .
B)
buying government securities in the open market .
C)
increasing the reserve ratio .
D)
decreasing the prime interest rate.
(38) Assume the required reserve ratio is 20 percent. If the Central bank buys 80
million in government securities from the public, then the money supply will
immediately :
A)
increase by kd 80 million, and the maximum money-lending potential
of the commercial banking system will increase by kd 80 million .
B)
increase by kd 80 million, but the maximum money-lending potential
of the commercial banking system will decrease by kd 80 million .
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C)
increase by kd 80 million, and the maximum money-lending potential
of the commercial banking system will increase by kd 400 million .
D)
decrease, because the securities are an asset to the commercial banks
and a liability to the Federal Reserve.
(39) The Central bank could increase the money supply by :
A)
selling government bonds on the open market .
B)
buying government bonds on the open market .
C)
raising interest rates .
D)
raising the discount rate.
(40) Assuming that the Central bank sells kd 40 million in government securities to
commercial banks and the reserve ratio is 20 percent, then the effect will be to reduce:
A)
excess reserves by kd 8 million.
B)
excess reserves by kd 200 million.
C)
the potential money supply by kd 200 million.
D)
the potential money supply by kd 400 million.
(41) Lowering the discount rate has the effect of :
A)
changing required into excess reserves .
B)
changing excess into required reserves .
C)
making it less expensive for commercial banks to borrow from the
central banks .
D)
forcing commercial banks to call in outstanding loans from their best
customers.
(42) The level of GDP will tend to increase when :
A)
reserve requirements are increased .
B)
there is an increase in the discount rate .
C)
the Central bank buys government securities in the open market .
D)
the Central bank sells government securities in the open market.
(43) Which of the following best describes what occurs when monetary authorities
sell government securities ?
A)
There is a decrease in the size of commercial banks' excess reserves,
the money supply increases, and interest rates fall, thereby causing a decrease
in investment spending and real GDP .
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B)
There is a decrease in the size of commercial banks' excess reserves,
the money supply decreases, and the interest rates rise, thereby causing a
decrease in investment spending and real GDP .
C)
There is a decrease in the size of commercial banks' excess reserves,
the money supply decreases, and interest rates rise, thereby causing an
increase in investment spending and real GDP .
D)
There is an increase in the size of commercial bank reserves, the
money supply increases, and interest rates fall, thereby causing an
increase in investment spending and real GDP.
(44) An increase in the money supply usually :
A)
increases the interest rate and increases aggregate demand .
B)
increases the interest rate and decreases aggregate demand .
C)
decreases the interest rate and increases aggregate demand .
D)
decreases the interest rate and decreases aggregate demand.
(45) If the Central bank officials attempt to pull the economy out of a recession when
the price level is relatively stable, the policies they would most likely use would be to :
A)
buy government securities and increase the discount rate .
B)
sell government securities and decrease the discount rate .
C)
buy government securities and decrease the discount rate .
D)
sell government securities and increase the discount rate.
(46) Assume the economy faces high unemployment but stable prices. Which
combination of government policies is most likely to reduce unemployment ?
A)
the purchase of government securities in the open market and an
increase in taxes
B)
the sale of government securities in the open market and a decrease in
taxes
C)
the sale of government securities in the open market and a decrease in
government spending
D)
the purchase of government securities in the open market and an
increase in government spending
(47) The major problem facing the economy is high unemployment and weak
economic growth. The inflation rate is low and stable. Therefore, the Central bank
decides to pursue a policy to increase the rate of economic growth. Which policy
changes would reinforce each other to achieve that objective ?
A)
selling government securities and raising the discount rate
B)
selling government securities and lowering the discount rate
C)
buying government securities and lowering the discount rate
D)
buying government securities and raising the reserve ratio
(48) Inflationary pressure is a growing problem for the economy. Therefore, the
Central bank decides to pursue a policy to reduce the inflationary pressure. Which
policy changes would reinforce each other to achieve that objective ?
A)
selling government securities and raising the discount rate
B)
selling government securities and lowering the discount rate
C)
buying government securities and lowering the discount rate
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D)
buying government securities and lowering the reserve ratio
(49) Suppose the economy is at full employment with a high inflation rate. Which
combination of government policies is least likely to reduce the inflation rate ?
A)
Buy government securities in the open market and increase taxes .
B)
Buy government securities in the open market and decrease taxes .
C)
Sell government securities in the open market and increase government
spending .
D)
Sell government securities in the open market and decrease
government spending.
(50) Which monetary policy would most likely increase aggregate demand ?
A)
increasing reserve requirements at commercial banks and thrift
institutions
B)
increasing margin requirements on stock purchases
C)
purchasing government securities in the open market
D)
increasing the discount rate
(51) In the near-vertical range of the aggregate supply curve, an easy money policy
would tend to produce a(n):
A)
increase in employment and a decrease in the price level .
B)
increase in output with little or no change in the price level .
C)
increase in the price level with little or no change in output .
D)
decrease in the price level with little or no change in output.
(52) An easy money policy would be most effective :
A)
in the vertical range of the aggregate supply curve .
B)
in the horizontal range of the aggregate supply curve .
C)
in the upsloping range of aggregate supply curve .
D)
there is cyclical asymmetry.
(53) An increase in the money supply will have its most significant effect on the price
level in:
A)
the horizontal range of the aggregate supply curve.
B)
the intermediate range of the aggregate supply curve.
C)
the vertical range of the aggregate supply curve.
D)
any of the three ranges of the aggregate supply curve.
Essay Questions :

What are the two reasons that people want to hold money? In other words,
what are the two types of demand for money?
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
Explain how the GDP and the interest rate are related to the transactions and
asset demands for money.

What is the goal of monetary policy?

What are the three principal tools of monetary policy? Explain how they can
be used.

Differentiate between easy and tight monetary policies.

How does monetary policy affect equilibrium GDP? How can it address the
problem of recession or slow growth? Inflation?