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Chapter 17 The Central Bank Balance Sheet and the Money Supply Process

Multiple Choice Questions 1. The collapse of the Thai currency, the baht, was partially due to: A) Inaction by the Federal Reserve. B) The European Central Bank. C) Information provided by the central bank of Thailand. D) Information not provided by the central bank of Thailand. Answer: D LOD: 1 Page: 427 A-Head: The Central Bank's Balance Sheet. 2. Each of the following items would appear as assets on the central bank's balance sheet, EXCEPT: A) Loans B) Securities C) Currency D) Foreign Exchange Reserves. Answer: C LOD: 1 Page: 428 A-Head: The Central Bank's Balance Sheet. 3. A central Bank's balance sheet will categorize the following as liabilities: A) Currency B) Loans C) Securities D) Foreign Exchange Reserves E) a and c Answer: A LOD: 1 Page: 428 A-Head: The Central Bank's Balance Sheet. 4. A central bank's balance sheet would categorize each of the following as liabilities, EXCEPT: A) Currency B) Loans C) Securities D) Accounts of the Commercial Banks Answer: B LOD: 1 Page: 428 A-Head: The Central Bank's Balance Sheet.
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5. The main asset held by a central bank in its role as the Banker's Bank is: A) Foreign Exchange Reserves B) Currency C) Loans D) Securities Answer: C LOD: 1 Page: 428 A-Head: The Central Bank's Balance Sheet. 6. A liability of the central bank in functioning as the Banker' Bank is: A) Accounts of commercial banks B) Securities C) Loans D) Currency Answer: A LOD: 1 Page: 428 A-Head: The Central Bank's Balance Sheet. 7. For the Federal Reserve's balance sheet, the asset listed Securities would include: A) Private and public debt. B) Mainly U.S. Treasury and municipal bonds. C) Bonds issued by commercial banks. D) Only U.S. Treasury securities and small quantities of Federal Agency Obligations. Answer: D LOD: 2 Page: 428 A-Head: The Central Bank's Balance Sheet. 8. If the Federal Reserve is to be independent, the quantity of securities it purchases is determined by: A) The Federal Reserve itself. B) Congress. C) The amount the public does not want to purchase at the going price. D) The Treasury. Answer: A LOD: 2 Page: 428 A-Head: The Central Bank's Balance Sheet.

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9. A central bank holds foreign exchange reserves primarily for: A) Diversification purposes. B) Foreign exchange market interventions. C) Safekeeping. D) All of the above. Answer: B LOD: 2 Page: 428 A-Head: The Central Bank's Balance Sheet. 10. The quantity of securities held by the Federal Reserve is controlled by: A) The U.S. Treasury. B) The Fed's annual budget. C) Open market operations. D) The purchases made by the regional Reserve banks. Answer: C LOD: 2 Page: 428 A-Head: The Central Bank's Balance Sheet. 11. In the U.S., loans made by Federal Reserve to banks fall in the categories of: A) Discount loans B) Reserves. C) Float. D) a and c E) a and b Answer: D LOD: 1 Page: 429 A-Head: The Central Bank's Balance Sheet. 12. Which of the following statements is most correct? A) Discount loans are initiated by the Federal Reserve. B) Discount loans are made when banks need small amounts of cash for the long term. C) Float is a byproduct of the Fed's check clearing business. D) Float loans are initiated by the commercial banks. Answer: C LOD: 2 Page: 429 A-Head: The Central Bank's Balance Sheet.

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13. Immediately following the terrorists attacks of September 11, 2001, the float in the banking system in the U.S.: A) Fell dramatically. B) Because of quick action by the Fed it stayed fairly constant. C) Increased dramatically. D) Increased but only by about ten percent. Answer: C LOD: 1 Page: 439 A-Head: Changing the Size and the Composition of the Balance Sheet. 14. A change that increases the Fed's speed at clearing checks would cause the amount of float to: A) Decrease B) Increase C) Stay the same, since the speed of clearing checks doesn't impact the float. D) Increase, but only until the system adjust. Answer: A LOD: 2 Page: 429 A-Head: The Central Bank's Balance Sheet. 15. If the U.S. evolves into a checkless society, where funds are transferred electronically, the amount of float should: A) Increase B) Decrease a little. C) Not change. D) Almost disappear. Answer: D LOD: 2 Page: 429 A-Head: The Central Bank's Balance Sheet. 16. Gold is: A) The most important asset on the Fed's balance sheet. B) Extremely important as an asset for the Fed. C) Almost irrelevant for the Fed. D) Very important for monetary policy in the U.S. Answer: C LOD: 2 Page: 429 A-Head: The Central Bank's Balance Sheet.

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17. For the Federal Reserve, the largest liability on their balance sheet is: A) Reserves. B) Non-bank currency. C) Government accounts. D) Treasury certificates. Answer: B LOD: 1 Page: 430 A-Head: The Central Bank's Balance Sheet. 18. Over ninety percent of the Fed's liabilities is in: A) Government accounts. B) Treasury certificates. C) Reserves. D) Non-bank currency. Answer: D LOD: 1 Page: 430 A-Head: The Central Bank's Balance Sheet. 19. Compared to the Federal Reserve, the European Central Bank (ECB): A) Has a smaller percentage of their liabilities in currency B) Has a larger percentage of their liabilities in currency. C) Has about the same percentage of their liabilities in currency. D) The ECB does not issue currency. Answer: A LOD: 2 Page: 430 A-Head: The Central Bank's Balance Sheet. 20. Which of the following statements is most correct? A) Reserves are assets of the central bank and liabilities of the U.S. Treasury. B) Reserves are assets of the central banks and liabilities of the commercial banks. C) Reserves are liabilities of the commercial banks and assets of the U.S. Treasury. D) None of the above. Answer: D LOD: 2 Page: 430 A-Head: The Central Bank's Balance Sheet.

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21. Reserves are: A) Assets of the central bank and liabilities of the commercial bank. B) Assets of the commercial banks and liabilities of the central bank. C) Liabilities of the commercial and central banks. D) None of the above. Answer: B LOD: 2 Page: 430 A-Head: The Central Bank's Balance Sheet. 22. Vault cash is: A) Reserves but an asset of the central bank. B) Not reserves but is a liability of the central bank. C) A part of reserves and an asset of commercial banks. D) Not reserves but is an asset of central banks. Answer: C LOD: 2 Page: 430 A-Head: The Central Bank's Balance Sheet. 23. Vault cash is not included in the central bank's liability category of currency because: A) Only non-bank currency is in the liability category of currency. B) Vault cash really is only electronic funds. C) Vault cash is in the liability category of reserves. D) a and c E) b and c Answer: D LOD: 2 Page: 430 A-Head: The Central Bank's Balance Sheet. 24. The reserves of the commercial banks in the euro area far exceed the reserves of U.S. commercial banks. This is primarily due to the fact that: A) The banks in the euro area can count more assets as reserves. B) The European Central Bank pays interest on reserves, the Fed does not. C) The European Central Bank has a much higher required reserve rate. D) All of the above. Answer: B LOD: 2 Page: 430 A-Head: The Central Bank's Balance Sheet.

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25. Monetary policy operations for central banks are run through changes in the liability category of: A) Government's Accounts. B) Currency. C) Reserves. D) Gold. Answer: C LOD: 2 Page: 430 A-Head: The Central Bank's Balance Sheet. 26. Which of the following statements is most correct? A) During the 1990s Americans held more cash than Europeans but the amount of cash Americans held per resident decreased. B) During the 1990s the amount of cash held by Americans increased and we hold more cash per resident than Europeans. C) Americans hold less cash per resident than Europeans and the amount of cash held by American increased during the 1990s. D) Americans hold less cash than Europeans and the amount of cash held by American per resident decreased during the 1990s. Answer: C LOD: 2 Page: 431 A-Head: The Central Bank's Balance Sheet. 27. Most responsible central banks publish their balance sheet: A) At least once a year. B) Quarterly. C) Weekly D) Semi-annually. Answer: C LOD: 1 Page: 431 A-Head: The Central Bank's Balance Sheet. 28. The experience of the Marcos Presidency in the Philippines in 1986 showed: A) The importance of keeping the central bank independent from political pressure. B) Central bank balance sheets do not always project reality. C) Transparency is critical if people are going to trust a central bank. D) All of the above. Answer: D LOD: 2 Page: 431 A-Head: The Central Bank's Balance Sheet.
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29. The monetary base is the sum of: A) Reserves and M2. B) M1 and reserves. C) Non-bank currency, reserves and M1 D) None of the above. Answer: D LOD: 1 Page: 432 A-Head: The Central Bank's Balance Sheet. 30. The monetary base is the sum of: A) Reserves and non-bank currency B) Reserves and M2 C) Non bank currency and M2 D) None of the above. Answer: A LOD: 1 Page: 432 A-Head: The Central Bank's Balance Sheet. 31. The monetary base is also known as: A) M1 B) M2 C) High powered money. D) Free reserves. Answer: C LOD: 1 Page: 432 A-Head: The Central Bank's Balance Sheet. 32. In dollar amounts: A) The monetary base is larger than M2 and M1 is less than M2. B) M1 is smaller than the monetary base and M2 is larger than both. C) The monetary base is larger than M1 and M2. D) The monetary base is smaller than M1 and M2 is larger than M1. E) None of the above. Answer: D LOD: 2 Page: 432 A-Head: The Central Bank's Balance Sheet.

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33. One trait a central bank has over other businesses including banks is: A) It receives all of its funding from the government. B) It can control its balance sheet at will. C) It doesn't have stockholders. D) It doesn't have a board of directors. Answer: B LOD: 2 Page: 432 A-Head: Changing the Size and the Composition of the Balance Sheet. 34. When the Federal Reserve purchases a U.S. Treasury bond for $1 million by writing a check, when the check returns, the Fed's balance sheet will show: A) An increase in assets and a decrease in liabilities of $1 million. B) Only an increase in assets of $1 million. C) Only an increase in liabilities of $1million. D) An increase in assets and liabilities of $1 million. Answer: D LOD: 2 Page: 432 A-Head: Changing the Size and the Composition of the Balance Sheet. 35. When a business purchases a $25,000 computer system by writing a check, the business's balance sheet will: A) Show an increase in assets and liabilities of $25,000. B) Only show an increase in assets of $25,000. C) Only show an increase in liabilities of $25,000. D) None of the above. Answer: D LOD: 2 Page: 432 A-Head: Changing the Size and the Composition of the Balance Sheet. 36. When a business purchases a $50,000 computer system by writing a check, the business's balance sheet will: A) Only show an increase in liabilities of $50,000. B) Show an increase in assets and liabilities for $50,000. C) Not reflect any increase in assets or liabilities, only a change in the composition of assets. D) Only show an increase in assets of $50,000. E) None of the above. Answer: C LOD: 2 Page: 432 A-Head: Changing the Size and the Composition of the Balance Sheet.
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37. A central bank's purchase of securities made by writing checks on itself will: A) Decrease the size of its balance sheet. B) Have no impact at all on the balance sheet. C) Increase the size of their balance sheet. D) Only change the composition of its assets. Answer: C LOD: 2 Page: 432 A-Head: Changing the Size and the Composition of the Balance Sheet. 38. A central bank's sale of securities from their portfolio will: A) Decrease the size of its balance sheet. B) Have no impact at all on the balance sheet. C) Only change the composition of its liabilities. D) Only change the composition of its assets. Answer: A LOD: 2 Page: 433 A-Head: Changing the Size and the Composition of the Balance Sheet. 39. Considering a central bank's balance sheet, when the value of an asset increases: A) Nothing happens to its balance sheet. B) A liability must increase. C) The value of another asset must decrease. D) Either the value of another asset decreases or a liability must increase. E) None of the above. Answer: D LOD: 2 Page: 433 A-Head: Changing the Size and the Composition of the Balance Sheet. 40. Considering a central bank's balance sheet, when the value of a liability decreases: A) Nothing happens to its balance sheet. B) Either the value of another liability increases or an asset must decrease. C) The value of another liability must increase. D) An asset must decrease. E) None of the above. Answer: B LOD: 2 Page: 433 A-Head: Changing the Size and the Composition of the Balance Sheet.

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41. Consider a $2 billion open market purchase of U.S. Treasury securities by the Federal Reserve. The Fed's balance sheet will specifically show: A) Only an increase in the asset of securities of $2 billion. B) Only show an increase in the liability of reserves of $2 billion. C) Show no change in the size of the balance sheet, just the composition of assets will change from cash to securities. D) Show an increase in the asset category of securities and the liability category of reserves by $2 billion. Answer: D LOD: 2 Page: 434 A-Head: Changing the Size and the Composition of the Balance Sheet. 42. Consider a $2 billion open market purchase of U.S. Treasury securities by the Federal Reserve. The Banking System's balance sheet will specifically show: A) Only an increase in liabilities of $2 billion. B) Only a decrease in assets of $2 billion. C) No net change in assets or liabilities, only a change in the composition of assets with securities decreasing and reserves increasing by $2 billion respectively. D) No net change in assets or liabilities, only a change in the composition of assets with securities increasing and reserves decreasing by $2 billion respectively. Answer: C LOD: 2 Page: 434 A-Head: Changing the Size and the Composition of the Balance Sheet. 43. An open market sale of U.S. Treasury securities by the Fed will cause the Fed's balance sheet to show: A) A decrease in the asset of securities and a decrease in the liability of reserves. B) An increase in the liability of reserves. C) No change in the size of the balance sheet, just the composition of assets will change from securities to cash. D) An increase in the asset category of securities and the liability category of reserves. Answer: A LOD: 2 Page: 434 A-Head: Changing the Size and the Composition of the Balance Sheet.

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44. An open market sale of U.S. Treasury securities by the Fed will cause the Banking System's balance sheet to show: A) Only an increase in liabilities. B) Only a decrease in assets. C) No net change in assets or liabilities, only a change in the composition of assets with securities decreasing and reserves increasing. D) No net change in assets or liabilities, only a change in the composition of assets with securities increasing and reserves decreasing. Answer: D LOD: 2 Page: 434 A-Head: Changing the Size and the Composition of the Balance Sheet. 45. The Fed purchases German bonds from commercial banks. Which of the following best describes the impact on the Fed's and the Banking System's balance sheets resulting from the purchase? A) The Fed's assets and liabilities increase, the banking systems assets and liabilities decrease. B) The Fed's assets increase and their liabilities increase, for the banking system, the value of assets and liabilities do not change, only the composition of assets changes. C) The Fed's assets and liabilities do not change, only the compositions of the assets change. For the banking system, assets and liabilities increase. D) The Fed's assets increase and their liabilities decrease, for the banking system, the value of assets and liabilities do not change, only the composition of assets changes. Answer: B LOD: 3 Page: 435 A-Head: Changing the Size and the Composition of the Balance Sheet.

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46. The Fed sells German bonds to commercial banks. Which of the following best describes the impact on the Fed's and the Banking System's balance sheets resulting from the purchase? A) The Fed's assets and liabilities increase, the banking systems assets and liabilities decrease. B) The Fed's assets increase and their liabilities increase, for the banking system, the value of assets and liabilities do not change, only the composition of assets changes. C) The Fed's assets and liabilities do not change, only the compositions of the assets change. For the banking system, assets and liabilities increase. D) The Fed's assets decrease and their liabilities increase, for the banking system, the value of assets and liabilities do not change, only the composition of assets changes. Answer: D LOD: 3 Page: 435 A-Head: Changing the Size and the Composition of the Balance Sheet. 47. To obtain a discount loan from the Fed, a commercial bank must: A) Prove that it will fail if it does not obtain the loan. B) Prove that the loan will be used to make loans. C) Provide collateral. D) All of the above. Answer: C LOD: 2 Page: 436 A-Head: Changing the Size and the Composition of the Balance Sheet. 48. When the Fed makes a discount loan, the impact on the Fed's balance sheet will reflect: A) No change in liabilities but an increase in assets. B) A decrease in assets and liabilities. C) An increase in assets and liabilities. D) An increase in assets and a decrease in liabilities. Answer: C LOD: 2 Page: 436 A-Head: Changing the Size and the Composition of the Balance Sheet.

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49. When the Fed makes a discount loan, the impact on the Banking System's balance sheet will reflect: A) An increase in liabilities with no change in assets. B) An increase in assets and a decrease in liabilities. C) A decrease in assets and an increase in liabilities. D) None of the above. Answer: D LOD: 2 Page: 436 A-Head: Changing the Size and the Composition of the Balance Sheet. 50. When the Fed makes a discount loan, the impact on the Banking System's balance sheet will reflect: A) An increase in liabilities with no change in assets. B) An increase in assets and a decrease in liabilities. C) A decrease in assets and an increase in liabilities. D) An increase in assets and liabilities. Answer: D LOD: 2 Page: 436 A-Head: Changing the Size and the Composition of the Balance Sheet. 51. Mary decides to withdraw $500 out of her checking account. The impact of this transaction on the Banking System's balance sheet will be: A) To only reduce checkable deposits by $500. B) To increase reserves and reduce checkable deposits by $500 respectively. C) To decrease reserves and checkable deposits by $500 respectively. D) To only reduce reserves by the required reserve rate times $500. Answer: C LOD: 2 Page: 437 A-Head: Changing the Size and the Composition of the Balance Sheet. 52. Tom decides to withdraw $300 out of his checking account. The impact of this transaction on the Fed's balance sheet will be: A) No change in total assets or total liabilities, but an increase in the liability of currency and decrease in the liability of reserves by $300 respectively. B) No change in total assets but the liability of currency increase by $300. C) Total assets decrease by $300 and the liability of currency increase by $300. D) None of the above. Answer: A LOD: 2 Page: 437 A-Head: Changing the Size and the Composition of the Balance Sheet.
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53. When an individual withdraws funds from their checking account, this increases the Fed's liability of currency because: A) Non-bank currency is a liability of the Fed. B) If currency is in the bank it falls under the liability category of reserves. C) Currency is an asset of the Fed as long as it is in a bank. D) a and b E) a and c Answer: D LOD: 2 Page: 438 A-Head: Changing the Size and the Composition of the Balance Sheet. 54. Harry gets $1000 in currency from his grandfather when he graduates from college. He deposits these funds into his checking account. Considering Harry's personal balance sheet: A) His assets increased by $1000 when he deposited the $1000 into his checking account. B) His assets increased when he received the $1000 in currency from his grandfather. C) His assets and liabilities increased by $1000 when he deposited the funds into his checking account. D) None of the above. Answer: B LOD: 2 Page: 437 A-Head: Changing the Size and the Composition of the Balance Sheet. 55. Harry gets $1000 in currency from his grandfather when he graduates from college. He deposits these funds into his checking account. What is the impact on the monetary base of Harry's deposit? A) The monetary base did not change. B) The monetary base increased by $1000. C) The monetary base decreased by $1000. D) The monetary base increases by more than a $1000. Answer: A LOD: 2 Page: 438 A-Head: Changing the Size and the Composition of the Balance Sheet.

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56. The term for turning reserves into bank deposits is called: A) Discounting. B) The money multiplier. C) Multiple deposit creation. D) Spreading. Answer: C LOD: 1 Page: 440 A-Head: The Deposit Expansion Multiplier. 57. If Bank A sells a $100,000 U.S. Treasury bond to the Fed, Bank A's required reserves will: A) Not change. B) Increase by $100,000. C) Decrease. D) Increase but by less than $100,000. Answer: A LOD: 2 Page: 440 A-Head: The Deposit Expansion Multiplier. 58. If Bank A sells a $100,000 U.S. Treasury bond to the Fed, Bank A's reserves will: A) Increase by $100,000. B) Increase by less than $100,000. C) Not change. D) Decrease. Answer: A LOD: 2 Page: 440 A-Head: The Deposit Expansion Multiplier. 59. If Bank A sells a $100,000 U.S. Treasury bond to the Fed, Bank A's excess reserves will: A) Increase by less than $100,000. B) Not change. C) Decrease by less than $100,000. D) Increase by $100,000. Answer: D LOD: 2 Page: 440 A-Head: The Deposit Expansion Multiplier.

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60. The most a bank could lend at any time without altering its assets is an amount equal to its: A) Checkable deposits. B) Reserves. C) Excess reserves. D) Net worth. Answer: C LOD: 2 Page: 440 A-Head: The Deposit Expansion Multiplier. 61. Bank A has checkable deposits of $100 million, vault cash equaling $1 million and deposits at the Fed equaling $14 million. If the required reserve rate is ten percent what is the maximum amount Bank A could lend: A) $85 million. B) $15 million. C) $14 million. D) $5 million. Answer: D LOD: 3 Page: 440 A-Head: The Deposit Expansion Multiplier. 62. Bank A has checkable deposits of $140 million, vault cash equaling $1 million and deposits at the Fed equaling $14 million. If the required reserve rate is ten percent what is the amount of excess reserves Bank A is holding: A) They do not have any excess reserves. B) $15 million. C) $2 million. D) None of the above. Answer: D LOD: 3 Page: 440 A-Head: The Deposit Expansion Multiplier.

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63. A customer of Bank A writes a $20,000 check for a new car, which the car dealer deposits in his bank, Bank B. Which of the following statements pertaining to this transaction is most true? A) Banks A's reserves will decrease by the required reserve rate times $20,000 and Banks B's reserves will increase by (1- required reserve rate) times $20,000. B) Bank A's reserves decrease by $20,000 and Bank B's reserves increase by $20,000. C) Neither Bank A's or B's reserves will change. D) Bank B's reserves will decrease and Bank A's reserves will increase by $20,000. Answer: B LOD: 3 Page: 442 A-Head: The Deposit Expansion Multiplier. 64. If the required reserve rate is ten percent and banks do not hold any excess reserves and there are no changes in currency holdings, a $1 million open market purchase by the Fed will result in deposit creation of: A) $9 million B) $90 million. C) $10 million. D) $900,000. Answer: C LOD: 3 Page: 444 A-Head: The Deposit Expansion Multiplier. 65. The formula for required reserves is: A) (1/rD ) D B) 1/rD C) rDD D) D/rD Answer: C LOD: 2 Page: 444 A-Head: The Deposit Expansion Multiplier.

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66. If required reserves are expressed by RR; the required reserve rate by rD and deposits by D, the simple deposit expansion multiplier is expressed as: A) rDD B) (1/rD ) D C) rD D) 1/rD Answer: D LOD: 2 Page: 444 A-Head: The Deposit Expansion Multiplier. 67. If the Fed were to increase the required reserve rate from ten percent to twenty percent, the simple deposit expansion multiplier would: A) Double. B) Increase by 10 percent. C) Decrease by a factor of ten. D) Be half as large as it was before the increase. Answer: D LOD: 3 Page: 444 A-Head: The Deposit Expansion Multiplier. 68. If the Fed were to decrease the required reserve rate from ten percent to five percent, the simple deposit expansion multiplier would: A) Double. B) Decrease by 5 percent. C) Increase by a factor of five. D) Be half as large as it was before the reduction. Answer: A LOD: 3 Page: 444 A-Head: The Deposit Expansion Multiplier. 69. If the required reserve rate is ten percent and banks do not hold any excess reserves and there are no changes in currency holdings, a $1 million open market purchase by the Fed will result in what change in loans: A) No change. B) A decrease of $1 million. C) An increase of $10 million D) An increase of $1 million. Answer: C LOD: 3 Page: 444 A-Head: The Deposit Expansion Multiplier.
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70. If we focus on the banking system and assume no change in the public's currency holdings, a loss of reserves by any one bank must: A) Equal the loss of reserves by the entire system. B) Be equal to the net loss of reserves for the banking system. C) Will result in no change in reserves for the banking system. D) None of the above. Answer: C LOD: 2 Page: 445 A-Head: The Deposit Expansion Multiplier. 71. If we assume a ten percent required reserve rate, and banks not holding any excess reserves and no change in currency holdings, an open market sale of $5 million of U.S. Treasury securities by the Fed, will result in deposits: A) Decreasing by $50 million. B) Increasing by $5 million. C) Increasing by $50 million D) Not changing. Answer: A LOD: 3 Page: 444 A-Head: The Deposit Expansion Multiplier. 72. The simple deposit expansion multiplier is really too simple for understanding the link between changes in a central bank's balance sheet and the quantity of money in the economy because: A) It ignores how central banks could change their balance sheet. B) It assumes banks loan out all excess reserves. C) It ignores people might change their currency holdings. D) a and b E) b and c Answer: E LOD: 2 Page: 445 A-Head: The Monetary Base and the Money Supply.

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73. Assume that the required reserve rate is ten percent, banks want to hold excess reserves in an amount that equals three percent of deposits, and the public withdraws ten percent of every deposit in cash. An open market purchase of $1million by the Fed will see banking system deposits increase by: A) More than $1 million but less than $10 million. B) Exactly $1 million. C) Less than $1 million. D) More than $10 million but less than $20 million. Answer: A LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply. 74. Which of the following best completes the statement? If people increase their currency holdings, all else the same, the monetary base A) Does not change but the quantity of M2 will decrease. B) The monetary base increases as does the quantity of M2. C) The monetary base decreases as does the quantity of M2. D) There is no change to either the monetary base or M2. Answer: A LOD: 3 Page: 449 A-Head: The Monetary Base and the Money Supply. 75. If there were an increase in the number of bank failures, we should expect the amount of excess reserves in the banking system to: A) Decrease. B) Increase. C) Not change. D) Decrease since failing banks lost theirs. Answer: B LOD: 2 Page: 447 A-Head: The Monetary Base and the Money Supply.

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76. If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR equals required reserves, and ER = Excess reserves, then C + R would equal: A) M B) R C) MB D) ER Answer: C LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply. 77. If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR equals required reserves, and ER = Excess reserves, then RR would equal: A) MB B) D C C) M/MB D) R - ER Answer: D LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply. 78. If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR equals required reserves, and ER = excess reserves, then m would equal: A) R/ER B) M/MB C) C + D D) None of the above. Answer: B LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply.

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79. If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR equals required reserves, rD = the required reserve rate and ER = Excess reserves, then RR would equal: A) R ER B) rD D C) (MB C) - ER D) All of the above E) None of the above. Answer: D LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply. 80. If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR equals required reserves, rD = the required reserve rate and ER = Excess reserves, then C + D would equal: A) M B) m C) MB D) ER/RR Answer: A LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply. 81. If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR equals required reserves, rD = the required reserve rate and ER = Excess reserves, then C + D would equal: A) MB times m B) R/ER C) D rD D) None of the above. Answer: A LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply.

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82. If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR equals required reserves, rD = the required reserve rate and ER = Excess reserves, then ER/D would equal: A) The amount in excess reserves. B) The amount in reserves. C) The excess reserve rate. D) The money multiplier. Answer: C LOD: 2 Page: 448 A-Head: The Monetary Base and the Money Supply. 83. If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR equals required reserves, rD = the required reserve rate and ER = Excess reserves, then RR/D would equal: A) The amount in Required Reserves. B) The required reserve rate. C) The amount in Excess Reserves. D) The monetary base. Answer: B LOD: 2 Page: 448 A-Head: The Monetary Base and the Money Supply. 84. The money multiplier is much lower today than it was twenty-five years ago because: A) People are holding less currency today. B) The currency to deposit ratio is much higher today. C) There is less currency available today. D) None of the above. Answer: B LOD: 2 Page: 450 A-Head: The Monetary Base and the Money Supply. 85. During the Great Depression, the monetary base in the U.S.: A) Decreased significantly. B) Increased. C) Remained constant. D) Was highly erratic, Answer: B LOD: 2 Page: 452 A-Head: The Monetary Base and the Money Supply.
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86. During the early years of the Great Depression, the monetary base and M2: A) Both increased significantly. B) Both decreased significantly. C) M2 increased while the monetary base decreased. D) The monetary base increased but M2 decreased. Answer: D LOD: 2 Page: 452 A-Head: The Monetary Base and the Money Supply. 87. During the early years of the Great Depression, a study of the money aggregates reveals that: A) The money multiplier was at an all-time high. B) The money multiplier increased from 1929 right through the 1936. C) The money multiplier actually decreased. D) The money multiplier was constant from 1929 through 1936. Answer: C LOD: 2 Page: 452 A-Head: The Monetary Base and the Money Supply. 88. One thing the Fed has learned over the past twenty-five years is: A) The money multiplier is fairly constant no matter what changes are made to the monetary base. B) The theory of the money multiplier isn't very useful. C) The money multiplier has a trend rate of growth that is fairly constant. D) They should focus their attention on targeting M2. Answer: B LOD: 2 Page: 450 A-Head: The Monetary Base and the Money Supply. 89. During the 1990s, the money multipliers for M1 and M2: A) Decreased. B) Remained fairly constant even though the economy grew. C) The M1 multiplier decreased while the M2 multiplier increased dramatically. D) Increased dramatically as the economy grew. Answer: A LOD: 2 Page: 456 A-Head: The Monetary Base and the Money Supply.

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Short Answer Questions 90. The author opens Chapter 17 with a contrast between the Fed's actions in response to the terrorist attacks of September, 2001 and their response to the financial crisis of the Great Depression. Why was the Fed successful at dealing with the crisis in 2001, and not as successful with the crisis of the early 1930s? Answer: The primary difference is that in the early 1930s the Fed failed to recognize the link between changes in the Fed's balance sheet and the growth rate of money. They believed that as long as they provided more cash to the economy and the account balances of commercial banks at the Fed were growing that credit and money were easily available. They were wrong. LOD: 2 Page: 426 A-Head: The Central Bank's Balance Sheet. 91. The assets that appear on the central bank's balance sheet include the category of loans. Who are central banks lending to and are these associated with the central bank functioning as the government's bank? Explain. Answer: The loans are usually made to commercial banks. Using the example of the Federal Reserve, these would be discount loans and float. This is not a central bank functioning as the government's bank; these loans are made as the central bank functions as the banker's bank. LOD: 2 Page: 428 A-Head: The Central Bank's Balance Sheet. 92. The Federal Reserve's Balance sheet would include an item labeled Currency. Is this an asset or a liability of the Fed and does it include all currency that is printed? Explain. Answer: The currency is a liability since it is an asset of whoever is holding it. As a result, the currency in this category only includes non-bank currency, or the currency that is in the hands of the public and does not include vault cash which is part of the banking system's reserves. LOD: 2 Page: 430 A-Head: The Central Bank's Balance Sheet.

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93. If the central banks of most countries do not set the exchange rates, why do they hold foreign exchange as one of their assets? Answer: Central banks hold foreign exchange reserves for those rare instances when the central bank intervenes in the foreign exchange market. The instances of intervention are rare, especially for the Federal Reserve. LOD: 2 Page: 428 A-Head: The Central Bank's Balance Sheet. 94. One of the assets on the Fed's balance sheet would be a category of loans called float. How is float created? Answer: Float is created as a by-product of the Fed's check-clearing system. When a bank presents the checks their customers have deposited with them to the Fed, the Fed will credit the bank's reserve account for the amount of the checks. The banks whose customers wrote the checks will not have the funds taken from their reserve account until the checks are transported to the Fed district of the bank. Once the checks arrive in the proper district the banks' reserve accounts are debited for the value of the checks. The Fed in essence has made a loan to the check writer and their bank. Under normal conditions float in the U.S. rarely exceeds several hundred million dollars. LOD: 2 Page: 429 A-Head: The Central Bank's Balance Sheet. 95. Discuss what likely happens to the amount of float and why, as electronic payments become more popular. Answer: As electronic payments become more popular we should see the amount of float in the banking system decrease. The float that occurs now is primarily the result of having to physically transport checks to the home Fed district of the bank on which the check is written. As electronic payments increase the number of checks needing to be transported will diminish and so will the float. It is conceivable that if paper checks are done away with entirely float could disappear. LOD: 2 Page: 429 A-Head: The Central Bank's Balance Sheet.

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96. Reserves are liabilities for central banks. Why is it that in the Euro area reserves are almost three times greater than they are for U.S. commercial banks, even after adjusting for the exchange rate? Answer: The likely answer is that in the Euro area the European Central Bank pays interest on reserves where the Fed does not. As a result, the cost of holding reserves is lower in the Euro area than in the United States and like most things, as the price increases the quantity decreases. LOD: 2 Page: 430 A-Head: The Central Bank's Balance Sheet. 97. Given the prevalence of electronic payment mechanisms like credit cards and debit cards and the safety of checks, why is the amount of currency in the hands of the public increasing? Answer: There are a couple of reasons, for one, a lot of illegal transactions are carried out using currency, however, if this were the only reason currency would probably be banned. Most people have transactions they carry out where they prefer to be anonymous. While checks and electronic payments are relatively safe, they do transfer a lot of information to the receiver, account numbers, names, addresses, etc. Also in some cases currency transactions are faster, for example picking up a meal at a drive thru restaurant, or paying for a newspaper, can usually be accomplished quickly with currency. LOD: 2 Page: 431 A-Head: The Central Bank's Balance Sheet. 98. Why do most central banks publish their balance sheets so frequently? Answer: This is part of a central bank's disclosure and transparency. Because central banks can control the size of their balance sheets it is important to reveal to the public what the central bank is doing. This is the main tool people can use to find out if central banks are doing their job properly. Delays in publishing the balance sheet can also delay the discovery of a potential problem. LOD: 2 Page: 431 A-Head: The Central Bank's Balance Sheet.

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99. If you write a check in the amount of $300 to your college bookstore for your textbooks, in terms of balance sheets, discuss briefly the impact on yours, your bank's and the Fed's balance sheets. Answer: For the check writer, the balance sheet does not change in size and liabilities do not change at all. All that changes is the composition of assets. The student has an increase in the asset called textbooks for $300 and an equal decrease in the asset of bank deposits. For the student's bank, their liabilities customer deposits decrease by $300 but so will the asset of reserves decrease by the same amount. For the Fed, the transaction will not impact the size of their balance sheet, ignoring float, since the reduction in the reserves of one bank will be offset by an increase in reserves of another once the check is processed. LOD: 3 Page: 432 A-Head: Changing the Size and the Composition of the Balance Sheet. 100. Explain the impact on the Fed's balance sheet from a $10 million open market purchase of U.S. Treasury Securities. Be sure to identify which categories of assets and liabilities change and by what amounts. Answer: The purchase of the Treasury securities will increase the asset category called Securities by the amount of $10 million, which is usually the largest asset category for most central banks. The liability category of Reserves will also increase by $10 million. This is done as the Fed will credit the appropriate bank(s) reserve account(s) to pay for the securities. This reflects the Fed's ability to pay for assets by simply creating liabilities. LOD: 2 Page: 433 A-Head: Changing the Size and the Composition of the Balance Sheet. 101. Follow a $1 billion purchase of U.S. Treasury bonds by the Fed from commercial banks. Discuss the changes that occur to the balance sheet of the banking system and the balance sheet of the Fed. Answer: The balance sheet of the banking system doesn't change in size. The liabilities of the banking system do not change, and the total assets don't change, the composition of assets changes, with the asset of securities decreasing by $1 billion and the asset of reserves increasing by $1 billion. For the Fed the balance sheet increases by $1 billion on both sides. The asset of securities increases by $1 billion and the liability of reserves increases by $1 billion. LOD: 2 Page: 433 A-Head: Changing the Size and the Composition of the Balance Sheet.
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102. If the Fed sells euros valued at $100 million to commercial banks, will this change the size of the Fed's liabilities and assets? Explain. Answer: The liabilities of the Fed will decrease by $100 million. The sale of euros to commercial banks will deplete the reserves of commercial banks as the Fed debits these reserve accounts. On the asset side, the Fed's assets are also decreased by $100 million as the asset category of foreign exchange reserves is now $100 million smaller. LOD: 2 Page: 434 A-Head: Changing the Size and the Composition of the Balance Sheet. 103. The Treasury usually requires most businesses to regularly deposit taxes withheld from employees into accounts at designated commercial banks. On a regular basis, the funds in these accounts are transferred to the Treasury's account at the Fed. Discuss what is happening to the balance sheet of the banking system as the businesses are making deposits and these tax accounts are increasing. What happens to the Banking system's balance sheet when the funds are transferred to the Fed? Answer: As the deposits are made by businesses the liabilities of the banking system are increased since these deposits are assets for the Treasury and liabilities of the banks. The asset side of the balance sheet is also increasing as these funds are adding to reserves. Once the funds are transferred to the Fed the liabilities are decreased by the amount of the transfer but also assets are decreased as the reserve account of the appropriate banks will be debited by the Fed. LOD: 2 Page: 432 A-Head: Changing the Size and the Composition of the Balance Sheet.

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104. You receive a $1,000 gift from your grandmother when you graduate from college. Your grandmother withdrew the $1,000 from her checking account and gave you ten $100 bills. You deposit the ten bills into your checking account. Discuss the impact of these transactions on your grandmother's balance sheet, your balance sheet, and the Fed's balance sheet. Answer: Let's start with the grandmother. The only change for her is the asset side of her balance sheet, when she converted bank deposits to currency her assets didn't change, just the composition, with deposits decreasing by $1,000 and currency increasing by $1,000. Once she presents the gift to you, her assets (currency) will decrease by $1,000, but your asset of currency increases by $1,000. With your deposit of the $1,000 of currency into the bank, the composition of your assets changes from currency to deposits. Now for the Fed, when grandmother converts the $1,000 deposit into currency, the Fed's balance sheet changed only in terms of composition. The reserves decreased by $1,000 and the currency increased by $1,000. With your deposit of the $1000 of currency into the bank, the liability of currency decreased by $1,000 and the liability of reserves increased by$1,000. LOD: 3 Page: 436 A-Head: Changing the Size and the Composition of the Balance Sheet. 105. What happens to the monetary base if people, fearing a bank run, convert their checking deposits into currency holdings? Answer: The monetary base itself does not change. The monetary base is made up of non-bank (public) currency and reserves. When people withdrawal funds from their checking accounts banking system reserves decrease but are immediately replaced by increases in currency so the amount in the monetary base is not changed. LOD: 2 Page: 440 A-Head: The Deposit Expansion Multiplier.

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106. The required reserve rate set by the Fed is ten percent of all checkable deposits. A bank sells $1 million of U.S. Treasury securities it owns to the Fed. Describe what this transaction does to the banks total reserves, its required reserves and its excess reserves. Answer: The sale of the securities will immediately increase the bank's reserves by the value of the sale which in this case is $1 million. Since the bank's liabilities have not changed, the required reserves for the bank have not changed. As a result, the $1 million increase in reserves is all excess reserves. LOD: 2 Page: 441 A-Head: The Deposit Expansion Multiplier. 107. If reserves do not earn any interest for the bank, why would a bank hold any excess reserves? Answer: While it is true that reserves do not pay any interest in the U.S., there can be an opportunity cost to not having them. For example, if customer liquidity (cash) demands are higher than expected a bank would face the cost of having to become liquid. That could mean selling securities or other assets or borrowing to meet those needs. Another possibility involves uncertainty regarding interest rates. If a banker believes interest rates may rise in the near future, it may be profitable to hold reserves rather than to purchase assets at a lower interest rate than what could have been obtained by waiting. LOD: 2 Page: 446 A-Head: The Monetary Base and the Money Supply. 108. Traveler's checks have no reserve requirements and are included in M1. When people travel during the summer and convert some of their checking account deposits into traveler's checks, explain what happens to the monetary base. Answer: The monetary base is the sum of reserves and currency in the hands of the public. So to answer the question we need to consider what happens to public currency and what happens to reserves. Since traveler's checks do not alter public currency nor do they deplete the banking system of reserves, the conversion of checkable deposits to traveler's checks does not alter the monetary base. LOD: 3 Page: 445 A-Head: The Monetary Base and the Money Supply.

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109. Why is it more correct to say that the Fed (the central bank) controls the monetary base than to say it controls the amount of reserves? Answer: The Fed, or any central bank, can create and destroy the monetary base by changing the size of their balance sheet. What they can't control is the currency holdings of the public. If people decide to hold more currency than the banking system will be depleted of reserves, but the monetary base does not change since it is the sum of reserves and public currency holdings. LOD: 2 Page: 446 A-Head: The Deposit Expansion Multiplier. 110. If we assume the required reserve rate is ten percent (0.1), and that the public does not change their currency holdings and that banks do not hold any excess reserves, what will be the change in deposits resulting from a $150 million open market purchase by the Fed?
D = 1 RR rD

Answer: We can use the following equation: where D = the change in deposits, rD = the required reserve rate, and RR is the change in required reserves. When the Fed purchases $150 million of securities in the open market, these become banking system reserves, since one of our assumptions is the banking system does not hold any excess reserves, banks will expand deposits (make loans) until the $150 million injection of reserves are being used as required reserves. Inserting the values of 0.1 for rD and $150 million for RR; the D = $1.5 billion. LOD: 3 Page: 444 A-Head: The Deposit Expansion Multiplier. 111. Why would it be correct to say that, if we assume that people do not change their currency holdings and that banks do not hold any excess reserves, the equation
D = 1 RR rD

really could be stated as

M 1 =

1 RR rD

Answer: M1 consists of public (non-bank) currency and checkable deposits (D). Any M1 = C + D; Since the C = 0; any M1 = D LOD: 3 Page: 444 A-Head: The Deposit Expansion Multiplier.

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112. What would be the change in deposits resulting from a $10 million open market purchase by the Fed if we assume the required reserve rate is ten percent (0.1) and that banks will hold excess reserves in the amount of two percent (0.02) of deposits? Answer: We know that MB = C + R so given we know B and C we can solve for R; in this case R = $1.7 $0.5; or $1.2 billion. The money multiplier, m, is M/MB; we know BB = $1.7 billion and M = $10.2 billion. So m = $10.2/$1.7 = 6.0, the money multiplier in this case is 6.0. LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply. 113. Total banking system reserves equal $58.65 billion. The total banking system checkable deposits subject to reserve requirements are $510 billion. The required reserves are $51 billion. What is the required reserve rate, and what is the excess reserve rate? Answer: Given the required reserves equal $51 billion and there are $510 billion in deposits; we can use the formula: where D = Deposits and RR equals required reserves, and rD = the required reserve rate. Substituting in the amounts we find rD = 0.1 or ten percent. We can take the same approach to solving for the excess reserve if we first take the total amount of reserves which we will call R and realizing that R = RR + ER where ER is the amount in excess reserves. In this case, ER = R RR or $7.65 billion. Now if we let rE represent the excess reserve rate, we can solve for it using the following equation: and substituting in the actual values, we find that rE = 0.015 or 1.5percent. LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply. 114. What would be the amount of deposits D, given that the monetary base MB = $750 billion, the required reserve rate (rD) = 0.1, the excess reserve rate (rE) = 0.005, and non-bank currency to deposits (C/D) equaled 1.2?
D= 1 xMB C / D + rD + rE rE = ER D rD = RR D

Answer: We can solve for D using the following equation: substituting in the values given, we obtain $574.7 billion. LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply.
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115. What was the main reason the Fed stopped announcing growth targets for money aggregates in the early 2000s? Answer: The main reason is that the link between the monetary base and the supply of M2 and M3 seemed to breakdown in the sense that it was constant or predictable. This meant that the money multiplier is unstable or unpredictable. Control of the monetary base does not give central bankers control over the money aggregates over a two or three year period which is usually the horizon used for short term policy making. LOD: 2 Page: 455 A-Head: The Monetary Base and the Money Supply. 116. You are given the following information: Reserves (R) in the banking system amount to $48 billion, of which $45.8 billion are required. Currency in the hands of the public amounts to $692.5 billion while checkable deposits amount to $650 billion. Calculate the money multiplier.
m= 1+ C / D rD + rE + C / D

Answer: We can answer this one by using the following formula:

We need to calculate C/D, this we can obtain by using information given in the question. C = $692.5 (we'll leave off the billions) and D = $650; so C/D = $692.5/$650 = 1.065. Next we'll calculate rD which can be found by rD = RR/D where RR represents the required reserves. rD = $45.8/$650 or 0.07; Next we can find rE by first determining the amount in excess reserves, ER. ER = R RR or ER = $48- $45.8 = $2.2. rE = ER/D = $2.2/$650 = 0.0033. We have all of the values we need to solve for m. Substituting the values we obtained into the equation above, we find that m = 2.065/1.138 or m = 2.35. LOD: 3 Page: 448 A-Head: The Monetary Base and the Money Supply.

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Essay Questions 117. If banks never held any excess reserves and if the currency holdings of the public never changed, do you think the Fed would still focus on an interest rate target? LOD: 3 Page: 446 Answer: One thing we saw from the chapter that under the assumptions of banks not holding any excess reserves and the demand for currency being constant, the deposit expansion multiplier is quite large and would also be constant, or predictable. If the Fed could rely on the constancy or predictability of deposit expansion resulting from a change in the monetary base, (which in this case would be a change in reserves since the currency holding by the public would be constant) targeting a money aggregate may work since the relationship between a change in reserves and the money target would be stable. The problem the Fed faces today is that the link between a change in the monetary base and the money supply (such as M2) is unpredictable because the Fed cannot control what banks will do with excess reserves nor do they control currency holdings by the public. So instead of targeting a money aggregate they settle on an interest rate. One other note, if the Fed were to target a money aggregate, they would have to give up targeting an interest rate because they cannot do both. A-Head: The Monetary Base and the Money Supply.

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118. Within two days following the September 11, 2001 terrorists attacks, the float in the banking system increased by almost a hundred fold. Float is an asset of the Fed since it represents loans being made to banks by the Fed, yet this dramatic increase in float caused the Fed to actually have to increase reserves to keep the payments system from coming to a halt. Explain why this was the case. LOD: 2 Page: 439 Answer: While it is true that float represents loans to banks, the problem was that a few large banks were able to receive payments but not make them. So these large banks were absorbing reserves and not passing reserves on to other banks which needed them to make payments. The Fed seeing the consequences if this continued reacted by making reserves available to any bank that needed them. Within a two day period following the attacks the Fed increased banking system reserves by $145 billion which they reduced over the next few days as the system returned to normal operations. A-Head: Changing the Size and the Composition of the Balance Sheet. 119. Considering changes to the monetary base, are discount loans and federal funds borrowing equivalent? Explain. LOD: 3 Page: 448 Answer: When a bank borrows in the federal bunds market reserves are just being moved from one bank to another so the monetary base does not change. As we learned in the chapter, the banking system does not have the ability to create or destroy the monetary base. When a bank borrows directly from the Fed by obtaining a discount loan, this increases the Fed's balance sheet, adding the asset of the loan and the liability of the reserves to their balance sheet. The injection of the reserves does increase the monetary base and as we saw can have an impact on the money supply. So in terms of the impact on the monetary base, a discount loan and borrowing in the federal funds market are not equivalent. A-Head: The Monetary Base and the Money Supply.

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