Iowa State University
Department of Economics
Econ353: Section 2
Spring 2003
Sample Test 3: Short Questions
Chapter 9: The Banking Firm and the Management of Financial Institutions
Questions and Problems: Questions 11, 12, 13, 14 and 15 on pages 246 and 247 of your
textbook.
Chapter 15: Multiple Deposit Creation and the Money Supply Process
Question 1:
Using T-accounts for both the banking system and the Fed for part (a) and the nonbank
public, the banking system and the Fed for parts (b) and (c), show:
a) how a Federal Reserve sale of $100 of government bonds to banks will affect the
monetary base and reserves
b) how a Federal Reserve sale of $100 of government bonds to the nonbank public
will affect the monetary base and reserves if the nonbank public pays for the
bonds in checks
c) how a Federal Reserve sale of $100 of government bonds to the nonbank public
will affect the monetary base ad reserves if the nonbank public pays for the bonds
in currency
d) how does the answer in part (c) differ from those in parts (a) and (b).
Question 2:
Using T-accounts for the First National Bank and the Fed, show
a) What happens when the Fed sells $100,000 of T-bills to the First National Bank;
what has happened to reserves in the banking system?
b) What happens if the First National Bank pays off a $100,000 discount loan; what
has happened to reserves in the banking system?
Question 3:
a) Assume that the required reserve ratio is 0.20 and that the Fed purchases $1000 in
government bonds from the First State Bank of Bozeman, which, in turn, lends
the $1000 of reserves it has just acquired to a customer for the purchase of a used
car. If the used car dealer deposits the proceeds from the sale in Bank A, how
much in additional loans can Bank A make? What is the change in the money
supply after Bank A lends this amount?
b) Assume a similar process occurs for Bank B, Bank C, and Bank D. Complete the
following table for these banks (see Table 3, page 405 in the text for an example)
and the totals for all banks.
Bank
A
B
C
D
.
.
.
Total
All banks
Change in Deposits
+ $1000.00
+ $800.00
__________
__________
Change in Loans
+ $800.00
+ $640.00
_________
_________
Change in Reserves
+ $200.00
+ $160.00
_________
_________
__________
_________
_________
Question 4:
a) Write down the formula for the simple deposit multiplier.
b) Assuming that the required reserve ratio is 0.20, what is the change in reserves
when the Fed sells $10 billion of government bonds and extends discount loans of
$5 billion to commercial banks?
c) Using the simple deposit multiplier formula, calculate the resulting change in
checkable deposits.
Chapter 17: Tools of Monetary Policy
Question 1:
Using the supply and demand in the market for reserves and starting from the point of
equilibrium (see Figure 1 on page 436 of your textbook), show what happens to the
demand and/or the supply curves (i.e., shifts) and what happens to the federal funds rate
if:
a) the Fed purchases U.S. Treasury securities,
b) the Fed lowers the discount rate.
Question 2:
a) Why is open market operations the most important monetary policy tool?
b) What are the two types of open market operations?
c) List the advantages of open market operations?
d) List the three types of discount loans.
e) Why might it be important to have a lender of last resort even with the existence
of deposit insurance?
f) List two reasons why changes in reserve requirements are rarely used as a policy
tool to conduct monetary policy.
Chapter 18: Conduct of Monetary Policy: Goals and Targets
Question 1:
a) Although there is some ambiguity as to whether a particular variable is better
categorized as an intermediate target or an operating target, list three variables
generally thought to be intermediate targets and two variables generally thought
to be operating targets.
b) Selecting an intermediate target requires careful thought by members of the
Federal Open Market Committee. The wrong choice can mean adverse
consequences for the economy. Debate has tended to center around the choice
between targeting a monetary aggregate or an interest rate. List the three criteria
for choosing one variable as an intermediate target over another.
Question 2:
For the information given, use the Taylor rule to determine the appropriate setting of the
federal funds rate under the assumption that the Fed uses the Taylor rule to determine the
appropriate federal funds interest rate.
Inflation Rate
Equilibrium
Federal Funds
Rate
Inflation Target
3%
4%
4%
4%
4%
5%
1%
1%
2%
2%
2%
2%
2%
2%
2%
2%
2%
2%
2%
2%
2%
2%
2%
2%
Percentage
Deviation of
Real GDP from
Potential GDP
1%
1%
2%
-1%
-2%
1%
-2%
1%
Federal Funds
Rate