Q: Which of the following equations correctly defines M1, or transactions money, in the United States?

$$M1 \equiv \text{currency held outside banks} + \text{demand deposits} + \text{traveler's checks} + \text{other checkable deposits}$$

Q: If the required reserve ratio is 10%, what is the value of the money multiplier?

$$\text{Money multiplier} = \frac{1}{0.10} = 10$$

Q: A bank has $$200 million in deposits and the required reserve ratio is 20%. If the bank holds 60 $$million in reserves, what are its excess reserves?

$$\text{Excess reserves} = 60 - (0.20 \times 200) = 60 - 40 = 20$$ million

Question 1

Which of the following best describes the three main functions of money in an economy?

Accepted Answer

A means of payment, a store of value, and a unit of account.

Question 2

Why do commodity monies such as red feather rolls or dolphin teeth make better money than coconut shells?

Accepted Answer

Because they have intrinsic value and are scarce, making them difficult to counterfeit.

Question 3

Which of the following equations correctly defines M1, or transactions money, in the United States?

Accepted Answer

$$M1 \equiv 	ext{currency held outside banks} + 	ext{demand deposits} + 	ext{traveler's checks} + 	ext{other checkable deposits}$$

Question 4

If the required reserve ratio is 10%, what is the value of the money multiplier?

Accepted Answer

$$	ext{Money multiplier} = \frac{1}{0.10} = 10$$

Question 5

Which of the following is NOT a tool traditionally used by the Federal Reserve to control the interest rate?

Accepted Answer

Changing the federal income tax rate.

Question 6

Suppose the Federal Reserve buys government securities in the open market. What is the likely short-term effect on the money supply and interest rates?

Accepted Answer

The money supply increases and interest rates decrease.

Question 7

Which of the following best explains why the value of money falls when the prices of goods and services rise?

Accepted Answer

Because money loses purchasing power as inflation increases.

Question 8

A bank has $$200 million in deposits and the required reserve ratio is 20%. If the bank holds 60 $$million in reserves, what are its excess reserves?

Accepted Answer

$$	ext{Excess reserves} = 60 - (0.20 	imes 200) = 60 - 40 = 20$$ million

Question 9

Which of the following statements about the Federal Open Market Committee (FOMC) is correct?

Accepted Answer

It sets goals concerning the money supply and interest rates and directs open market operations.

Question 10

If the interest rate on government securities rises, what happens to the price of existing bonds?

Accepted Answer

The price of existing bonds falls.

Question 11

Which of the following best describes the relationship between the quantity of money demanded and the interest rate?

Accepted Answer

The quantity of money demanded is negatively related to the interest rate.

Question 12

Which of the following is a reason for holding money according to the motives discussed in the chapter?

Accepted Answer

Transaction motive: to buy goods and services.

Question 13

If the Fed increases the money supply from $$M_0 to$$ $$M_1$$, what happens to the equilibrium interest rate according to the money market diagram?

Accepted Answer

The equilibrium interest rate falls from $$r_0 to$$ $$r_1.$$

Question 14

According to the expectations theory of the term structure of interest rates, how is the 2-year interest rate determined?

Accepted Answer

It is equal to the average of the current 1-year rate and the 1-year rate expected a year from now.

Question 15

Which of the following is a liability on a bank's balance sheet?

Accepted Answer

Deposits

Question 16

What is the main disadvantage of using money as a store of value?

Accepted Answer

Its value falls when the prices of goods and services rise.

Question 17

If a bank experiences a 'run on the bank,' what is most likely to happen?

Accepted Answer

Many depositors try to withdraw their money at the same time, potentially causing the bank to fail.

Question 18

Which of the following best describes 'fiat money'?

Accepted Answer

Money that is designated as legal tender by the government but has no intrinsic value.

Question 19

If the required reserve ratio is 20% and there is an initial deposit of $1000, what is the maximum possible increase in total deposits in the banking system?

Accepted Answer

$$	ext{Maximum increase} = \frac{1}{0.20} 	imes 1000 = 5000$$

Money, the Federal Reserve, and the Interest Rate: Structured Study Notes

Study Guide - Practice Questions

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