Questions for Review

CHAPTER 29

SOLUTIONS TO TEXT PROBLEMS:

Quick Quizzes

1. The three functions of money are: (1) medium of exchange; (2) unit of account; and (3) store of value. Money is used as a medium of exchange because money is the item people use to purchase goods and services. Money is used as a unit of account because it is the yardstick people use to post prices and record debts. Money is used as a store of value because it is an item people use to transfer purchasing power from the present to the future.

2. The primary responsibilities of the Federal Reserve are to regulate banks, ensuring the health of the banking system, and to control the quantity of money that is made available in the economy. If the Fed wants to increase the supply of money, it usually does so by creating dollars and using them to purchase government bonds from the public in the nation’s bond markets.

3. Banks create money when they make loans and hold a fraction of the amount of the loans in reserves, resulting in an expansion of both money and credit in the economy. If the Fed wanted to use all three of its tools to decrease the money supply, it would: (1) sell government bonds from its portfolio in the open market to reduce the number of dollars in circulation; (2) increase reserve requirements to reduce the money created by banks; and (3) increase the discount rate to discourage banks from borrowing reserves from the Fed.

Questions for Review

1. Money is different from other assets in the economy because it is the most liquid asset available. Other assets vary widely in their liquidity.

2. Commodity money is money with intrinsic value, like gold, which can be used for purposes other than as a medium of exchange. Fiat money is money without intrinsic value; it has no value other than its use as a medium of exchange. Our economy today uses fiat money.

3. Demand deposits are balances in bank accounts that depositors can access on demand simply by writing a check. They should be included in the stock of money because they can be as a medium of exchange.

4, 5. The Federal Open Market Committee (FOMC) is responsible for setting monetary policy in the United States. The FOMC consists of the seven members of the Federal Reserve Board of Governors and five of the 12 presidents of Federal Reserve Banks. Members of the Board of Governors are appointed by the president of the United States and confirmed by the U.S. Senate. The presidents of the Federal Reserve Banks are chosen by each bank’s board of directors.

6. If the Fed wants to increase the supply of money with open-market operations, it purchases U.S. government bonds from the public on the open market. The purchase increases the number of dollars in the hands of the public, thus raising the money supply.

7. Banks do not hold 100 percent reserves because it is more profitable to use the reserves to make loans, which earn interest, instead of leaving the money as reserves, which earn no interest. The amount of reserves banks hold is related to the amount of money the banking system creates through the money multiplier. The smaller the fraction of reserves banks hold, the larger the money multiplier, since each dollar of reserves is used to create more money.

8. The discount rate is the interest rate on loans that the Federal Reserve makes to banks. If the Fed raises the discount rate, fewer banks will borrow from the Fed, so banks' reserves will be lower, and thus the money supply will be lower.

9. Reserve requirements are regulations on the minimum amount of reserves that banks must hold against deposits. An increase in reserve requirements raises the reserve ratio, lowers the money multiplier, and decreases the money supply.

10. The Fed cannot control the money supply perfectly because: (1) the Fed does not control the amount of money that households choose to hold as deposits in banks; and (2) the Fed does not control the amount that bankers choose to lend. The actions of households and banks affect the money supply in ways the Fed cannot perfectly control or predict.

Date: 2015-12-24; view: 846