Chapter 25
Money Creation
1. European banks began with which of the following?
a. Monarchs were the first bankers, lending out cash to help the poor learn a craft.
b. Churches were the first bankers, lending out cash to help the poor learn a craft.
c. Goldsmiths were the first bankers, and the paper receipts they issued for gold held on
deposit became valued as money.
d. Fishermen were the first bankers, and the paper receipts they issued for fish they stored
in the hulls of their ships became valued as money.
ANS
a. Incorrect. Monarchs did not generally lend out their money to the poor.
b. Incorrect. Churches did not generally lend out their money to the poor.
c. Correct. In the Middle Ages, gold was the money of choice in European nations.
d. Incorrect. Fishermen did not store fish in the holds of their ships for long periods of
time, because unlike gold, the fish would spoil from prolonged storage.
2. Which of the following does not appear on the asset side of a bank's balance sheet?
a. required reserves
b. checkable deposits
c. loans
d. excess reserves
ANS
a. Incorrect. This appears on the asset side of a bank’s balance sheet.
b. Correct. Checkable deposits appear on the liability side of a bank’s balance sheet.
c. Incorrect. This appears on the asset side of a bank’s balance sheet.
d. Incorrect. This appears on the asset side of a bank’s balance sheet.
3. Which of the following is not an interest bearing asset of commercial banks?
a. required reserves.
b. securities.
c. loans.
d. All of the above are interest bearing assets of commercial banks.
ANS
a. Correct. The Fed pays no interest on required reserves.
b. Incorrect. Banks earn interest on this asset.
c. Incorrect. Banks earn interest on this asset.
d. Incorrect. Required reserves are not interest bearing.
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4. Banks would be expected to minimize holding excess reserves because this practice is
a. illegal.
b. not profitable.
c. technically difficult.
d. subject to a stiff excess reserves tax.
ANS
a. Incorrect. It is not illegal to hold excess reserves.
b. Correct. Excess reserves are not profitable because these funds earn no interest.
c. Incorrect. It is not technically difficult to hold excess reserves.
d. Incorrect. There is no tax on excess reserves.
5. Which of the following appears on the asset side of a bank's balance sheet?
a. excess reserves
b. loans.
c. required reserves.
d. None of the above answers are correct.
e. All of the above answers are correct.
ANS
a. Incorrect. Each of answers a., b., and c. are correct. See Balance Sheet 1 in the text.
b. Incorrect. Each of answers a., b., and c. are correct. See Balance Sheet 1 in the text.
c. Incorrect. Each of answers a., b., and c. are correct. See Balance Sheet 1 in the text.
d. Incorrect. Each of answers a., b., and c. are correct. See Balance Sheet 1 in the text.
e. Correct. Each of answers a., b., and c. are correct. See Balance Sheet 1 in the text.
6. Assume a simplified banking system in which all banks are subject to a uniform
reserve requirement of 20 percent and checkable deposits are the only form of money. A
bank that received a new checkable deposit of $10,000 would be able to extend new loans
up to a maximum of
a. $2,000.
b. $8,000.
c. $9,000.
d. $10,000.
ANS
a. Incorrect. See answer b. for the correct calculation.
b. Correct. 0.20 x $10,000 = $2,000 required reserve and $8,000 excess reserves for
loans.
c. Incorrect. See answer b. for the correct calculation.
d. Incorrect. See answer b. for the correct calculation.
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7. If the required reserve ratio is a uniform 25 percent on all deposits, the money
multiplier will be
a. 4.00.
b. 2.50.
c. 0.40.
d. 0.25.
ANS
a. Correct. MM = 1 / rrr = 1/.25 = 4.00.
b. Incorrect. See answer a. for the correct answer.
c. Incorrect. See answer a. for the correct answer.
d. Incorrect. See answer a. for the correct answer.
8. Assume a simplified banking system subject to a 20 percent required reserve ratio. If
there is an initial increase in excess reserves of $100,000, the money supply
a. increases $100,000.
b. increases $500,000.
c. increases $600,000.
d. decreases $500,000.
ANS
a. Incorrect. See answer b. for correct answer.
b. Correct. M1 = MM x ER; MM = 1/rrr = 1/.20 = 5; 5 x 100,000 = $500,000.
c. Incorrect. See answer b. for correct answer.
d. Incorrect. See answer b. for correct answer.
9. If the required reserve ratio decreases, the
a. money multiplier increases.
b. money multiplier decreases.
c. amount of excess reserves the bank has decreases.
d. money multiplier stays the same.
ANS
a. Correct. Since the money multiplier = 1/required reserve ratio, if the required reserve
ratio decreases, then the money multiplier increases.
b. Incorrect. Since the money multiplier = 1/required reserve ratio, if the required reserve
ratio decreases, then the money multiplier increases.
c. Incorrect. The amount of excess reserves increases.
d. Incorrect. Since the money multiplier = 1/required reserve ratio, if the required reserve
ratio decreases, then the money multiplier increases.
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10. Decisions regarding purchases and sales of government securities by the Fed are
made by the
a. Federal Deposit Insurance Commission (FDIC).
b. Discount Committee (DC).
c. Federal Open Market Committee (FOMC).
d. Federal Funds Committee (FFC).
ANS
a. Incorrect. This agency insures bank deposits.
b. Incorrect. This is a meaningless committee.
c. Correct. Decisions regarding purchases and sales of government securities by the Fed
are made by the Federal Open Market Committee (FOMC).
d. Incorrect. This is a meaningless committee.
11. The cost to a member bank of borrowing from the Federal Reserve is the
a. reserve requirement.
b. price of securities in the open market.
c. discount rate.
d. yield on government bonds.
ANS
a. Incorrect. This is the percent of checkable deposits that must be reserve requirements.
b. Incorrect. This is not the interest rate charged banks to meet this reserve requirement.
c. Correct. This is not the interest rate charged banks to meet this reserve requirement.
d. Incorrect. This is not the interest rate charged banks to meet this reserve requirement.
12. Which of the following policy actions by the Fed would cause the money supply to
decrease?
a. an open-market purchase of government securities
b. a decrease in required reserve ratios
c. an increase in the discount rate
d. a decrease in the discount rate
ANS
a. Incorrect. An open-market purchase increases the money supply.
b. Incorrect. A decrease in required reserve ratios increases the money supply.
c. Correct. A high discount rate causes banks to use their checkable deposits to fund
required reserves and excess decrease.
d. Incorrect. A lower discount rate causes banks to use their checkable deposits to fund
required reserves and excess decrease.
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13. The rate of interest charged by the Federal Reserve to member banks for reserves
borrowed from the Fed is the
a. federal funds rate.
b. discount rate.
c. repurchase rate.
d. Q-ceiling rate.
ANS
a. Incorrect. This is an interest rate determined among banks.
b. Correct. The rate of interest charged by the Federal Reserve to member banks for
reserves borrowed from the Fed is known as the discount rate.
c. Incorrect. This is not determined by the Fed.
d. Incorrect. This is a meaningless term.
14. Which of the following actions by the Fed would increase the money supply?
a. reducing the required reserve ratio
b. selling government bonds in the open market
c. increasing the discount rate
d. None of the above answers is correct.
ANS
a. Correct. This action means banks can lend a higher percent of their checkable deposits.
b. Incorrect. This action decreases the money supply.
c. Incorrect. This action decreases the money supply.
d. Incorrect. Answer a. is correct.
Exhibit 5 Lower Walloon National Bank
Assets
Reserves
$10,000
Liabilities
Checkable deposits
$10,000
15. In Exhibit 5, if the required reserve ratio is 20 percent for all banks, and every bank in
the banking system loans out all of its excess reserves, then a $10,000 deposit from Mr.
Brown in checkable deposits could create for the entire banking system
a. $8,000 worth of new money.
b. $2,000 worth of new money.
c. $10,000 worth of new money.
d. $40,000 worth of new money.
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ANS
a. Incorrect. See answer d. for the correct calculation.
b. Incorrect. See answer d. for the correct calculation.
c. Incorrect. See answer d. for the correct calculation.
d. Correct. 0.20 x $10,000 = $2,000 required reserves and $8,000 excess reserves; MM =
1/rrr = 1/0.20 = 5; MM x ER = 5 x $8,000 = $40,000.
16. The required reserve ratio for a bank is set by
a. Congress.
b. the bank itself.
c. the Treasury Department.
d. the banking system.
e. the Federal Reserve.
ANS
a. Incorrect. The required reserve is set by the Federal Reserve.
b. Incorrect. The required reserve is set by the Federal Reserve.
c. Incorrect. The required reserve is set by the Federal Reserve.
d. Incorrect. The required reserve is set by the Federal Reserve.
e. Correct. The required reserve is set by the Federal Reserve.
17. Assume we have a simplified banking system in balance-sheet equilibrium. Also
assume that all banks are subject to a uniform 10 percent reserve requirement and
demand deposits are the only form of money. A commercial bank receiving a new
demand deposit of $100 would be able to extend new loans in the amount of
a. $10.
b. $90.
c. $100.
d. $1,000.
ANS
a. Incorrect. 0.10 x $100 ($10) must be kept in required reserves and $90 is excess
reserves that a bank can use for loans.
b. Correct. 0.10 x $100 ($10) must be kept in required reserves and $90 is excess reserves
that a bank can use for loans.
c. Incorrect. 0.10 x $100 ($10) must be kept in required reserves and $90 is excess
reserves that a bank can use for loans.
d. Incorrect. 0.10 x $100 ($10) must be kept in required reserves and $90 is excess
reserves that a bank can use for loans.
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18. A bank faces a required reserve ratio of 5 percent. If the bank has $200 million of
checkable deposits and $15 million of total reserves, then how large are the bank's excess
reserves?
a. $0
b. $5 million
c. $10 million
d. $15 million
ANS
a. Incorrect. 0.05 x $200 million checkable deposits equals $10 million required reserves.
Total reserves - required reserves = excess reserves; $15 - $10 = $5 million.
b. Correct. 0.05 x $200 million checkable deposits equals $10 million required reserves.
Total reserves - required reserves = excess reserves; $15 - $10 = $5 million.
c. Incorrect. 0.05 x $200 million checkable deposits equals $10 million required reserves.
Total reserves - required reserves = excess reserves; $15 - $10 = $5 million.
d. Incorrect. 0.05 x $200 million checkable deposits equals $10 million required reserves.
Total reserves - required reserves = excess reserves; $15 - $10 = $5 million.
19. A bank currently has checkable deposits of $100,000, reserves of $30,000, and loans
of $70,000. If the required reserve ratio is lowered from 20 percent to 15 percent, this
bank can increase its loans by
a. $10,000.
b. $15,000.
c. $75,000.
d. $5,000.
e. $ 0.
ANS
a. Incorrect. At 20 percent required reserve ratio, required reserves are 0.20 x $100,000 =
$20,000. Since total reserves are $30,000, excess reserves are $10,000. At 15 percent
required reserve ratio, $5,000 is added to the $10,000 existing excess reserves.
b. Correct. At 20 percent required reserve ratio, required reserves are 0.20 x $100,000 =
$20,000. Since total reserves are $30,000, excess reserves are $10,000. At 15 percent
required reserve ratio, $5,000 is added to the $10,000 existing excess reserves.
c. Incorrect. At 20 percent required reserve ratio, required reserves are 0.20 x $100,000 =
$20,000. Since total reserves are $30,000, excess reserves are $10,000. At 15 percent
required reserve ratio, $5,000 is added to the $10,000 existing excess reserves.
d. Incorrect. At 20 percent required reserve ratio, required reserves are 0.20 x $100,000 =
$20,000. Since total reserves are $30,000, excess reserves are $10,000. At 15 percent
required reserve ratio, $5,000 is added to the $10,000 existing excess reserves.
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20. When the Fed purchases government securities, it
a. increases banks’ reserves and makes possible an increase in the money supply.
b. decreases banks’ reserves and makes possible a decrease in the money supply.
c. automatically raises the discount rate.
d. uses discounting operations to influence margin requirements.
e. has no effect on either the money supply or the discount rate.
ANS
a. Correct. A Fed purchase of securities is paid with a check deposited in the banking
system. This injection causes an increase in banks’ reserves and an increase in loans and
in turn the money supply.
b. Incorrect. A Fed purchase of securities is paid with a check deposited in the banking
system. This injection causes an increase in banks’ reserves and an increase in loans and
in turn the money supply.
c. Incorrect. A Fed purchase of securities is paid with a check deposited in the banking
system. This injection causes an increase in banks’ reserves and an increase in loans and
in turn the money supply.
d. Incorrect. A Fed purchase of securities is paid with a check deposited in the banking
system. This injection causes an increase in banks’ reserves and an increase in loans and
in turn the money supply.
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