1. Review of Monetary Policy

2. What backs the U. S. money supply
What backs the U.S. money supply? What determines the value of the dollar?
Nothing but the ability of the Fed to keep the money supply stable (not print too much and cause inflation). No gold or silver backs the money supply
It’s buying power.
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3. What are the three jobs of money and what job do they perform?
Medium of Exchange: Buying things
Unit of Account/Standard of Value: Tells how much things cost
Store of Value: Holding money for future use (hopefully investing it!)
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4. What does Asset Demand involve
What does Asset Demand involve? What does the Asset Demand Curve look like? Why?
Money held as an asset such as gold or silver. It is cash that earns little or no interest.
The Asset Demand Curve has an inverse relationship between the quantity of money held as a non-interest bearing asset and nominal interest rates. It slopes downward.
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5. What is the largest measure of the money supply. Why
What is the largest measure of the money supply? Why? What job does it perform? M3
because it includes M2 (& M1)
Store of value.
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6. What is the smallest measure of the money supply
What is the smallest measure of the money supply? What job does it perform? M1
Medium of Exchange.
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7. What is the main determinant of the Transactions Demand for Money
What is the main determinant of the Transactions Demand for Money? What type of relationship is this, direct or inverse? Why?
The level of Nominal GDP.
This is a direct relationship.
Because when prices of products increase, people need more money for daily purchases.
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8. What is the most important job of the Federal Reserve?
Monetary Policy.
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9. Why can the Fed make independent economic decisions that are good for the long-term health of the economy?
Because they are not elected officials. They are trained economists whose job is to ensure economic stability of the U.S. economy. Also, many, like the Chairman and members of the Board of Governors/Federal Open Market Committee, serve long terms.

10. money from the Fed purchase that counts in money creation.
Suppose the Fed buys $300 Billion in government securities from the public. with a
reserve ratio of 20%, what would be the maximum increase in the money supply?
Short-Cut Method: The Deposit Expansion Multiplier x Excess Reserves = 1/.20 = 5; 5 x $300 Billion = $1,500 Billion
Long Method (technically this is how it is done):
Required Reserves = reserve requirement x checkable deposits
= .20 x $300 Billion = $60 Billion
Excess Reserves = AR – ER
= $300 Billion - $60 Billion = $240 Billion
Multiplier = 1/rr = 5;
Expansion via loans = The Multiplier x Excess Reserves
= 5 x $240 Billion
= $1,200 Billion
Then: Add back the original deposit because it is all “new”
money from the Fed purchase that counts in money
creation.
$300 + $1,200 = $1,500 Billion

11. How do banks “create” money?
By making loans.

12. How do banks “destroy” money?
When loans are repaid.

13. Which cash reserves may banks lend?
Excess Reserves

14. Which cash reserves are banks prevented from lending?
Required Reserves

15. What are Actual or Total Reserves?
Required Reserves + Excess Reserves

16. What are the only cash reserves a bank has?
Required Reserves and Excess Reserves

17. Are bonds and loans on the Asset side of a bank cash?
No, they are promises to repay the bank, principal plus interest.

18. If you are asked to look at a Bank Balance Sheet and determine how much the bank may loan out or expand the money supply, do Loans and/or Bonds matter?
No, they don’t represent cash. They involve money already lent out or a bond that has been purchased. The money is already out the door. The only thing that a bank may loan out at that time is its excess reserves.

19. What is the Reserve Requirement?
The percentage of checkable deposits banks may not lend out.

20. reserve requirement x checkable deposits
How do you calculate required reserves?
reserve requirement x
checkable deposits

21. Required Reserves divided by Checkable Deposits
How do you calculate the reserve requirement?
Required Reserves divided by Checkable Deposits

22. By how much can one bank increase the money supply?
By the amount of its excess reserves.

23. By how much can the banking system increase the money supply?
By the amount of the Deposit Expansion Multiplier x Excess Reserves.

24. If a question states “a bank must keep a certain amount of reserves” what kind of reserves are being referred to?
Required Reserves

25. RR = $10 Million - $2 Million = $8 Million
If a bank’s Actual Reserves are $10 Million and its Excess Reserves are $2 Million, what are its Required Reserves?
RR = AR minus ER
RR = $10 Million - $2 Million = $8 Million

26. ER = $10 Million - $8.5 Million = $1.5 Million
If a bank’s Actual Reserves are $10 Million and its Required Reserves are $8.5 Million, what are its Excess Reserves?
ER = AR minus RR
ER = $10 Million - $8.5 Million = $1.5 Million

27. If the asset side of a bank’s balance sheet shows Reserves of $100 Million, what kind of cash reserves are they?
Total or Actual Reserves. They may be all Required Reserves or Required Reserves plus Excess Reserves

28. If the Asset side of a bank’s balance sheet shows Required Reserves of $10Million and Demand Deposits on the liability side are $100 Million, how do you determine what the reserve ratio is?
Reserve Ratio = Required Reserves divided by Demand
Deposits.

29. If the liability side of a bank’s balance sheet shows Demand Deposits of $100 Million, how do you determine how much of that amount is Required and/or Excess Reserves? Assume the reserve ratio is 10%.
You must:
Multiply the reserve requirement by Checkable Deposits. That will give you Required Reserves.
Then, subtract Required Reserves from Actual Reserves to find Excess Reserves.
For example:
a) If the reserve ratio is 10%, then you multiply .10 x $100
Million to get $10 Million or the amount of Required Reserves.
b) Next, subtract RR from AR to get ER. $100 Million - $10 Million = $90
Million or Excess Reserves.

30. What are the two ways money is “created”?
1) When Banks make loans.
2) When the Fed buys bonds
(government securities)
from the public or banks.

31. When money is “created,” and banks make loans, what happens to the money supply?
It increases

32. When someone deposits or withdraws money from their checking account, does the money supply change?
No. Only the composition changes. With a deposit, the composition changes from cash to a demand deposit. With a withdrawal, the composition changes from a demand deposit to cash.

33. What are the three tools of Monetary Policy?
1. Reserve Requirement
Discount Rate
Open Market Operations

34. What is the Reserve Requirement?
The percentage of checkable deposits banks cannot lend out.

35. What is the Discount Rate?
The interest rate charged by the Federal Reserves when it loans money to banks.

36. What are Open Market Operations?
Buying or selling of government securities by the Federal Reserve.

37. What is the Federal Funds Rate?
The interest rate charged by banks when they borrow from each other.

38. Does the Fed set the Federal Funds Rate?
No. It is set by market competition between banks.

39. How does the FED influence the Federal Fund Rate ?
By purchasing or selling government securities.

40. If the FED wants to decrease the Federal Funds Rate to increase the Money Supply and fight recession, what should it do?
By purchasing government securities. The money goes from the FED to the public and/or banks and increases economic activity.

41. If the FED wants to increase the Federal Funds Rate to decrease the Money Supply and fight inflation, what should it do?
By selling government securities. The money goes from the public and/or banks to the FED and decreases economic activity.

42. When using Expansionary Monetary Policy, what is the FED fighting?
Recession

43. When the FED fights recession, how does it use its 3 tools?
It decreases the Reserve Requirement. This creates more excess reserves that may be lent out. This increases the Money Supply and creates more economic
activity.
It decreases the Discount Rate. This makes it cheaper
for banks to borrow money from the FED and loan that
money to businesses and consumers, thus increasing the
Money Supply and creating more economic activity
It buys government securities from the public and/or banks.
This creates more excess reserves, increases the money
supply, and creates more economic activity.

44. When the FED fights inflation, how does it use its 3 tools?
It increases the Reserve Requirement. This creates fewer excess reserves that may be lent out. This decreases the Money Supply and creates less economic activity.
It increases the Discount Rate. This makes it more expensive
for banks to borrow money from the FED and loan that
money to businesses and consumers, thus decreasing the
Money Supply and creating less economic activity
It sells government securities to the public and/or banks.
This creates less excess reserves, decreases the money
supply, and creates less economic activity.

45. 1. Speed: it can be implemented fast.
What are two strengths of monetary policy?
1. Speed: it can be implemented fast.
2. Political Isolation: Fed members are not elected politicians
and can therefore make decisions that are best for the long-
term health of the economy.

46. List three weaknesses of Monetary Policy.
1. Ease and flow of electronic funds, etc. may undermine Fed action.
2. Changes in Velocity
3. Cyclical Asymmetry

47. What does Cyclical Asymmetry involve?
That the Fed is better at controlling inflation than solving recessions.
They can decrease the money supply and choke off inflation.
However, people and businesses may not want to borrow money no
matter how low the interest rate due to economic conditions,
business confidence, etc. Also the impact of monetary policy make
take 9 months to three years.

48. If Expansionary Monetary Policy is utilized, how do changes in velocity potentially hurt the efforts to improve the economy.
Because the nominal interest rate decreases, the amount of money held as an “asset” increases. This money is “idle” , not invested, and doesn’t create economic activity.

49. If Contractionary Monetary Policy is utilized, how do changes in velocity potentially hurt the efforts to reduce inflation?
Because the nominal interest rate increases, the amount of money held as an asset decreases. This money becomes “active”, is invested, creates economic activity.