Chapter 15

Question 1

what is fractional reserve banking?

Answer 1

a system in which banks keep only a percentage of their deposits on reserve as vault cash and deposits at the fed

Question 2

what are required reserves?

Answer 2

the minimum balance that eh fed required a bank to hold in vault cash or on deposit with the Fed

Question 3

what is the required reserve ratio?

Answer 3

the percentage of deposits that the fed requires a bank to hold in vault cash or on deposit with the Fed (usually 10%)

Question 4

what are excess reserves?

Answer 4

potential loan balances held in vault cash or on deposit with the Fed in excess of required reserves

Question 5

T or F when a bank makes a loan, it creates deposits, and the money supply increases by the amount of the loan because the money supply includes checkable deposits

Answer 5

True

Question 6

what is the money multiplier?

Answer 6

the maximum change in the money supply (checkable deposits) due to an initial change in the excess reserves banks hold. the money multiplier is equal to 1/required reserve ratio

Question 7

what is cash leakage

Answer 7

money outside the banking system in someone’s wallet or purse or underneath the mattress

Question 8

what is monetary policy

Answer 8

the federal reserve’s use of open market operations, changes in the discount rate, and changes in the required reserve ratio to change the money supply (M1)

Question 9

what are open market operations?

Answer 9

the buying and selling of government securities by the federal reserve system

Question 10

T or F , a purchase of government securities by the Fed injects reserves into the banking system and increases the money supply. A sale of government securities by the Fed reduces reserves in the banking system and decreases the money supply

Answer 10

True

Question 11

what are the directions of flow for open market operations?

Answer 11

Public > Banks decrease loans and destroy money > fed sells government securities and banks lose reserves

fed buys government securities and banks gain reserves > banks increase loans and create money > public

Question 12

what is a discount rate?

Answer 12

the interest rate the fed charges on loans of reserves to banks

Question 13

T or F a lower discount rate discourages banks from borrowing reserves and making loans, if the fed wants to expand the money supply it increases the discount rate. to contract the money supply the fed lowers the discount rate

Answer 13

False, a higher discount rate discourages banks from borrowing reserves and making loans. if the fed wants to expand the money supply, it reduces the discount rate. if the objectives is to contact the money supply, the fed raises the discount rate

Question 14

what are federal funds market?

Answer 14

a private market in which banks lend reserves to each other for less than 24 hours

Question 15

what is the federal funds rate

Answer 15

the interest rate banks charge for overnight loans of reserves to other banks

Question 16

what type of relationship is between the size of the required reserve ratio and the money multiplier

Answer 16

an inverse relationship

Question 17

what does the fed do to the required reserve ratio in order to affect the money supply

Answer 17

in order to increase the money supply it decreases the required reserve ratio, if the objective is to decrease the money supply, the fed increases the required reserve ratio. in reality, changing the required reserve ratio is considered a heavy handed approach that is an infrequently used tool of monetary policy