Introduction to finance 14e Melicher Norton Solutions manual and test bank
Chapter 4
Federal Reserve System
TRUE-FALSE QUESTIONS
1. The National Banking Act provides that national banks can issue their own notes only against U.S. government bonds that the banks held on deposit with large city banks.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Legislation
2. Because of the National Banking Act, the volume of national bank notes depends on the government bond market rather than the seasonal or cyclical needs of the nation for currency.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Legislation
3. The United States was one of the earliest major-industrial nations to adopt a permanent system of central banking.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank History
4. A central bank is a Federal government agency that facilitates operation of the financial system and regulates growth of the money supply.
Answer: T
Difficulty Level: Easy
Subject Heading: Central Bank Terminology
5. Although a central bank does not necessarily operate for profit, it generally deals directly with the public.
Answer: F
Difficulty Level: Medium
Subject Heading: Structure of Central Banking
6. A central bank is required to hold reserves, and it has stockholders and a board of directors.
Answer: T
Difficulty Level: Easy
Subject Heading: Structure of Central Banking
7. The Federal Reserve Advisory Council provides advice and general information to the Secretary of the Treasury.
Answer: F
Difficulty Level: Medium
Subject Heading: Structure of Central Banking
8. The Federal Reserve System replaced the system that existed under the National Banking Act.
Answer: F
Difficulty Level: Medium
Subject Heading: History of Central Banking
9. The Federal Reserve Act of 1913 provided that all national and state-chartered banks were to become members of the Fed.
Answer: F
Difficulty Level: Easy
Subject Heading: Central Bank Legislation
10. The Reserve Banks are private institutions owned by many member banks of the Fed.
Answer: T
Difficulty Level: Easy
Subject Heading: Structure of Central Banking
11. All commercial banks are members of the Fed.
Answer: F
Difficulty Level: Easy
Subject Heading: Structure of Central Banking
12. Open market operations involve the buying and selling of U.S. government securities.
Answer: T
Difficulty Level: Easy
Subject Heading: Central Bank Operations
13. In addition to the 12 Reserve Banks, 25 branch banks have been established.
Answer: T
Difficulty Level: Easy
Subject Heading: Structure of Central Banking
14. The Fed Board of Governors is composed of seven members who are appointed for a term of 12 years.
Answer: F
Difficulty Level: Medium
Subject Heading: Structure of Central Banking
15. The only bank asset that can be counted as reserve is deposits with the Reserve Banks.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Operations
16. The closer to the required minimum the banking system maintains its reserves, the tighter the control the Fed has over the money creation process through its other instruments.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Operations
17. The ability to change reserve requirement is a powerful tool the Fed uses frequently.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Operations
18. Banks are required by the Fed to hold reserves equal to a part of their deposits as part of the fractional reserve system of the U.S. banking system.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Operations
19. If excess reserves are near zero, then a reduction of reserves will cause the system to loosen credit.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Operations
20. The Fed lending rate to depository institutions was consistently lower than the bank prime lending rate during the 1977–1994 period.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Operations
21. Although not provided for in the original organization of the Fed, open market operations have become the most important and effective means of monetary control.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Operations
22. The Federal Reserve has no power to regulate the overseas activities of member banks and bank holding companies.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Operations
T 23. Total deposits can be contracted by holding the amount of reserves constant but raising the reserve requirement.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Operations
24. The money supply can be contracted by holding the amount of reserves constant but raising the reserve requirement.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Operations
25. The Fed prefers to change reserve requirements rather than to use open market operations.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Operations
26. When reserves are added to the banking system, depository institutions may expand their lending but are not forced to do so.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Operations
27. Banks with large transaction account balances hold the same percentage of reserves as all other banks.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Operations
28. Member banks of the Federal Reserve System may not borrow from the Fed.
Answer: F
Difficulty Level: Easy
Subject Heading: Structure of the Federal Reserve
29. A major weakness of the banking system under the National Banking Acts was that the money supply could not be easily expanded or contracted to meet changing seasonal needs and/or changes in economic activity.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank History
30. The United States was one of the last major industrial nations to adopt a permanent system of central banking.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank History
31. The Federated Requirement System (Fed) is the central bank of the United States and is responsible for setting monetary policy and regulating the banking system.
Answer: F
Difficulty Level: Easy
Subject Heading: Central Bank Terminology
32. The Federal Reserve act required that ALL national banks were to become members of the Fed.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Legislation
33. Paul Volcker was chairman of the Fed prior to the appointment of Alan Greenspan.
Answer: T
Difficulty Level: Easy
Subject Heading: Central Bank History
34. Open market operations are similar to discount operations in that they increase or decrease bank reserves at the initiative of the Fed.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Operations
35. Empirical evidence shows that in countries where central banks are relatively independent from their governments, there has been higher inflation and lower economic growth rates than in countries where central banks are closely tied to their governments.
Answer: F
Difficulty Level: Medium
Subject Heading: Structure of Central Banking
36. The essential requirements of a well-functioning financial system include an efficient national payments system, a flexible money supply, and a lending/borrowing mechanism to help alleviate liquidity problems when they arise.
Answer: T
Difficulty Level: Medium
Subject Heading: Structure of Central Banking
37. A central bank is a federal government agency that facilitates the operation of the financial system and regulates money supply growth.
Answer: T
Difficulty Level: Easy
Subject Heading: Central Bank Terminology
38. The Federal Open Market Committee directs open market operations by buying and selling government securities which are the primary instruments of exercising monetary policy.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Operations
39. The seven members of the Federal Reserve Board of Governors are responsible for the establishment of monetary policy.
Answer: T
Difficulty Level: Medium
Subject Heading: Structure of Central Banking
40. Federal Reserve actions that stimulate or repress the level of prices or economic activity are called dynamic actions.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Operations
41. Federal Reserve actions that stimulate or repress the level of prices or economic activity are called defensive activities.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Operations
42. Federal Reserve actions that meet the credit needs of individuals and institutions, clearing checks, and supporting depository institutions are called accommodative activities.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Operations
43. The minimum amount of total reserves that depository institutions must hold are called fractional reserves.
Answer: F
Difficulty Level: Easy
Subject Heading: Central Bank Terminology
44. The three primary means that the Fed can use to exercise monetary policy includes closed market operations, stabilizing reserve requirements, and freeing the Federal discount rate.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Operations
45. Since the late 1970s, the Federal Discount Rate has generally exceeded the Prime Interest Rate by a few percentage points.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank History
46. Since the late 1970s, the Federal Discount Rate has generally been below the Prime Interest Rate by a few percentage points.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank History
47. The Fed would be practicing contractionary monetary policy if, through open market operations, it is a net seller of government securities.
Answer: T
Difficulty Level: Medium
Subject Heading: Monetary Policy
48. The Fed would be practicing contractionary monetary policy if it caused a decrease in market interest rates.
Answer: F
Difficulty Level: Medium
Subject Heading: Monetary Policy
49. The Consumer Credit Protection Act requires that lenders clearly explain consumer credit costs and prohibited them from charging overly high-priced credit transactions.
Answer: T
Difficulty Level: Medium
Subject Heading: Central Bank Regulation
50. Regulation Z requires that lenders clearly explain consumer credit costs and prohibited them from charging overly high-priced credit transactions.
Answer: F
Difficulty Level: Medium
Subject Heading: Central Bank Regulation
MULTIPLE-CHOICE QUESTIONS
1. Under the authority of the Federal Reserve Act of 1913:
a. all national and state-chartered banks must become members of the Fed
b. only national banks were permitted to become members of the Fed
c. state-chartered banks were permitted to withdraw from membership with the Fed
d. a system of deposit insurance was created
Answer: c
Difficulty Level: Medium
Subject Heading: Central Bank Regulation
2. Under the authority of the Federal Reserve Act of 1913:
a. member banks were required to purchase capital stock in the Federal Reserve Banks of their district
b. member banks may not borrow from the Fed
c. a formal open-market committee arrangement was established
d. national banks were permitted to become members of the Fed if they could show evidence of satisfactory financial condition
Answer: a
Difficulty Level: Medium
Subject Heading: Central Bank Regulation
3. The primary function of the Federal Reserve System is to:
a. issue currency to member banks
b. regulate the growth of the money supply
c. serve as a fiscal agent for the U.S. government
d. regulate and conduct bank examinations
Answer: b
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
4. The members of the board of directors of each Federal Reserve bank are:
a. appointed by the Board of Governors of the Federal Reserve System
b. elected by the member banks
c. chosen by the Board of Governors and by the member banks
d. appointed by the President of the United States with the advice and consent of the Senate
Answer: c
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
5. Each member of the Fed Board of Governors is appointed for a term of:
a. 8 years
b. 12 years
c. 14 years
d. none of the above
Answer: c
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
6. The members of the Fed Board of Governors are:
a. elected by the member banks
b. appointed by the President of the United States with the advice and consent of the Senate
c. appointed by the Secretary of the Treasury
d. appointed by each of the Federal Reserve banks
e. none of the above
Answer: b
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
7. One of the major weaknesses of the banking system before the Federal Reserve System was set up was:
a. the arrangement for holding reserves
b. the lack of a deposit insurance system
c. a lack of currency and coin
d. an inadequate supply of government bonds
Answer: a
Difficulty Level: Medium
Subject Heading: Central Bank History
8. Before the Federal Reserve System was created, a large part of the reserves of commercial banks was:
a. in the form of state and federal government bonds
b. deposited with the United States Treasury
c. held as deposits with large city banks
d. held as cash in their vaults
Answer: c
Difficulty Level: Medium
Subject Heading: Central Bank History
9. The National Banking Act provided that:
a. national banks could issue their own notes only against U.S. government bonds the banks held on deposit with the Treasury
b. national banks could issue their own notes only against cash held in their vaults
c. national banks could issue their own notes only against U.S. government bonds the banks held on deposit with the Federal Reserve Bank
d. none of the above
Answer: a
Difficulty Level: Medium
Subject Heading: Central Bank Regulation
10. The United States created its system of central banking:
a. earlier than such banks were established in other industrial nations
b. later than such banks were established in other industrial nations
c. to facilitate branch banking
d. to facilitate international exchange operations
Answer: b
Difficulty Level: Medium
Subject Heading: Central Bank History
11. Member banks of the Federal Reserve System:
a. must maintain all reserves with their Federal Reserve Bank
b. may include deposits held at large city banks as legal reserves
c. maintain levels of reserves based on the size of the city in which they are located
d. are permitted to count vault cash as part of their reserves
Answer: d
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
12. A central bank does not:
a. deal directly with the public
b. necessarily operate for a profit
c. have stockholders because it is a non-profit organization
d. hold reserve requirements
Answer: b
Difficulty Level: Medium
Subject Heading: Structure of Central Banking
13. Under the Federal Reserve Act of 1913, the number of Federal Reserve districts established is:
a. 8
b. 10
c. 12
d. 25
Answer: c
Difficulty Level: Easy
Subject Heading: Central Bank Regulation
14. For which of the following are member banks prohibited from borrowing at the Fed’s discount window?
a. funds to meet reserve requirements
b. funds to meet depositor withdrawal demands
c. to meet business loan demands
d. all the above are permitted
e. none of the above are permitted
Answer: d
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
15. The discount rate is:
a. the rate charged a bank’s best customers
b. the rate paid by large business with good credit
c. the rate a bank must pay to borrow from the Fed
d. none of the above
Answer: c
Difficulty Level: Medium
Subject Heading: Central Bank Operations
16. Which of the following statements would be false? The discount rate is
a. an instrument of monetary policy
b. frequently used as a tool of fiscal policy
c. regarded as a fine-tuning mechanism
d. all the above are true
Answer: b
Difficulty Level: Medium
Subject Heading: Central Bank Operations
17. Open market operations:
a. are used infrequently
b. are a prime source of income for the U.S. economy
c. are used by the Fed to alter bank reserves
d. none of the above
Answer: c
Difficulty Level: Medium
Subject Heading: Central Bank Operations
18. Each Federal Reserve Bank has a president and first vice-president who are appointed by:
a. the Board of Governors
b. the President of the United States
c. the President of the United States with the advice and consent of the Senate
d. its board of directors
Answer: d
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
19. The Board of Governors:
a. is elected by the member banks
b. is appointed by the Senate
c. has seven members appointed for 14-year terms
d. has seven members appointed for a term of 12 years
Answer: c
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
20. The Federal Reserve System exercises its most direct control of the money supply:
a. by the issuance of Federal Reserve notes
b. through reserve requirements
c. by setting the discount rates on loans to depository institutions
d. through open market operations
Answer: d
Difficulty Level: Medium
Subject Heading: Function of the Federal Reserve
21. The principal examining activity of the Federal Reserve System is directed to:
a. all state-chartered banks
b. state-chartered member banks
c. all national banks
d. foreign banks operating in the United States
Answer: d
Difficulty Level: Medium
Subject Heading: Function of the Federal Reserve
22. The Federal Reserve Banks are owned by:
a. commercial banks
b. the U.S. Treasury
c. national member banks of the Federal Reserve System
d. member banks of the Federal Reserve System
Answer: d
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
23. All Federal Reserve Banks have:
a. check clearance facilities
b. branch banks
c. directors who are elected for 14-year terms
d. directors who are appointed by the President of the United States
Answer: a
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
24. In addition to the clearing of checks through Federal Reserve Banks, the Fed accommodates check clearing through:
a. check clearinghouses it sponsors in major cities
b. its branches and a group of regional check-processing centers
c. electronic transfers of funds
d. the United Postal Service
Answer: b
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
25. The Federal Reserve is empowered to encourage depository institutions to help meet the needs of communities for housing and other purposes:
a. through the Community Reinvestment Act
b. through the Truth in Lending Act
c. by a provision of the Fair Housing Act
d. by strictly enforcing usury laws setting maximum interest rates
Answer: a
Difficulty Level: Medium
Subject Heading: Function of the Federal Reserve
26. Bank holding companies are supervised and examined by:
a. the Comptroller of the Currency
b. the FDIC
c. the Federal Reserve
d. internal auditors only
Answer: d
Difficulty Level: Hard
Subject Heading: Function of the Federal Reserve
27. The Federal Open Market Committee:
a. is comprised of members of the Federal Reserve board and representatives of all Federal Reserve Banks
b. came into being at the time the Federal Reserve System was created
c. is made up of the presidents of the 12 Federal Reserve Banks
d. was created under a provision of the Banking Act of 1935
Answer: d
Difficulty Level: Medium
Subject Heading: Federal Reserve Legislation
28. The effect of an increase of required reserves by the Fed is:
a. a decrease in loanable funds of depository institutions
b. a decrease in interest rates
c. usually an increase in vault cash
d. to stimulate activity in the home construction field
Answer: a
Difficulty Level: Medium
Subject Heading: Federal Reserve Operations
29. The Federal Open Market Committee:
a. typically buys and sells long-term corporate bonds
b. is the most powerful and flexible monetary policy tool of the Fed
c. works out of Washington D.C.
d. deals with most of the commercial banks of the nation
Answer: b
Difficulty Level: Medium
Subject Heading: Federal Reserve Operations
30. It is generally agreed by the public that the Federal Reserve System:
a. should not engage in international exchange controls
b. carries out its functions reasonably well
c. is distrusted by business as well as by banking interests
d. should be under the control of the U.S. Treasury
Answer: b
Difficulty Level: Medium
Subject Heading: Function of the Federal Reserve
31. The Federal Reserve Banks now hold reserves for:
a. branches of foreign banks
b. only commercial banks, savings and loan associations, and credit unions
c. all of the reserve requirements of member banks
d. all of the reserve requirements of all depository institutions
Answer: a
Difficulty Level: Medium
Subject Heading: Function of the Federal Reserve
a 32. When the Federal Reserve System was created, it was thought that its most important influence over monetary conditions would be:
a. lending to banks to bolster their reserve positions
b. open market operations
c. the issuance of Federal Reserve notes
d. the changing of reserve requirements
Answer: a
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
33. The Fed shares its depository examining functions with:
a. the Federal Savings and Loan Insurance Corporation
b. the FDIC, Comptroller of the Currency, and state agencies
c. only the Comptroller of the Currency
d. National Credit Union administration and the FDIC
Answer: b
Difficulty Level: Medium
Subject Heading: Function of the Federal Reserve
34. The accommodative activities of the Federal Reserve System are:
a. clearing checks
b. meeting the credit needs of individuals and institutions
c. supporting depository institutions
d. all of the above
Answer: d
Difficulty Level: Medium
Subject Heading: Federal Reserve Operations
35. Eligible paper that the borrowing institution can sell to the Reserve Bank includes:
a. common stock
b. corporate bonds
c. U.S. government bonds
d. all of the above
Answer: c
Difficulty Level: Medium
Subject Heading: Federal Reserve Operations
36. The purpose of Regulation Z is to:
a. make consumers aware of the costs of alternative forms of credit
b. prohibit garnishment
c. encourage depository institutions to help meet the credit needs of their communities for housing and other purposes
d. regulate the overseas activities of member banks of the Federal Reserve System
Answer: a
Difficulty Level: Medium
Subject Heading: Federal Reserve Regulation
37. The Truth in Lending Act:
a. prohibits discrimination in the granting of credit on the basis of sex, race, color, and religion
b. limits liability on lost or stolen credit cards
c. prohibits unfair or deceptive acts or practices on the part of banks
d. requires prompt correction of errors on a revolving charge account
Answer: b
Difficulty Level: Medium
Subject Heading: Federal Reserve Legislation
38. The dynamic actions of the Federal Reserve System:
a. contribute to the smooth everyday functioning of the economy
b. are designed to meet the credit needs of individuals and institutions
c. support depositories and other institutions
d. stimulate or repress the level of prices or economic activity
Answer: d
Difficulty Level: Medium
Subject Heading: Federal Reserve Operations
39. The Federal Open Market Committee:
a. is made up of the presidents of the 12 Federal Reserve Banks
b. consists of the seven members of the Board of Governors of the Fed, plus five presidents of Reserve Banks
c. is appointed by the Chairman of the Federal Reserve System
d. none of the above
Answer: b
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
40. The payment mechanism of the Reserve Bank includes:
a. processing and clearing checks
b. issuing currency and coins
c. wire transfers
d. all the above
Answer: d
Difficulty Level: Medium
Subject Heading: Federal Reserve Operations
41. The National Banking Acts of 1863 and 1864 were:
a. totally eliminated under the Federal Reserve Act of 1913
b. were modified to permit greater flexibility of operations under the Federal Reserve Act of 1913
c. were unaffected by the Federal Reserve Act of 1913
d. none of the above
Answer: b
Difficulty Level: Medium
Subject Heading: Federal Reserve Legislation
42. The Board of Governors of the Federal Reserve System:
a. consists of 7 appointed members
b. sets reserve requirements
c. approves discount rates as part of monetary policy
d. all the above
e. none of the above
Answer: a
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
43. The Board of Governors of the Federal Reserve System:
a. oversee the supervision and regulation of member banks and bank holding companies
b. regulates reserve balance requirements for depository institutions
c. oversees the collection and clearance of checks for depository institutions
d. all the above
e. none of the above
Answer: d
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
44. The Federal Open Market committee:
a. establishes and administers protective consumer finance regulations
b. furnishes currencies
c. handles U.S. government debt and cash balances
d. all the above
e. none of the above
Answer: e
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
45. State-chartered banks:
a. automatically receive membership in the Federal Reserve System
b. are prohibited from membership in the Federal Reserve System
c. may be permitted to join the Federal Reserve system, given a satisfactory financial condition
d. none of the above
Answer: c
Difficulty Level: Medium
Subject Heading: Federal Reserve Regulation
46. Members of the Federal Reserve System may include:
a. commercial banks with a national charter
b. credit unions
c. savings and loan institutions
d. all the above
e. none of the above
Answer: a
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
47. The chairman of the Federal Reserve System:
a. is appointed by the Secretary of the Treasury
b. serves a life term
c. is the president of the New York Federal Reserve Bank
d. none of the above
Answer: d
Difficulty Level: Easy
Subject Heading: Federal Reserve Regulation
48. Three essential needs of a well-operating financial system include all of the following EXCEPT:
a. an efficient national payments system
b. an elastic or flexible money supply
c. a bank insurance system
d. a lending/borrowing mechanism
Answer: c
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
49. Which monetary policy tool does the Fed use most infrequently?
a. changing reserve requirements
b. changing the discount rate
c. open market operations
d. none of the above
Answer: a
Difficulty Level: Medium
Subject Heading: Monetary Policy
50. One significant feature of DIDMCA was that it:
a. expanded the ability of the Fed to influence unemployment rates
b. expanded Fed control over the reserve requirements of non-member banks
c. created the FDIC
d. none of the above
Answer: b
Difficulty Level: Medium
Subject Heading: Federal Reserve Regulation
51. During the past several years:
a. the discount rate has been lower than the prime rate
b. the discount rate has been higher than the prime rate
c. the discount rate has been unrelated to the prime rate
d. none of the above
Answer: a
Difficulty Level: Medium
Subject Heading: Federal Reserve History
52. The Fed has legal responsibility for administering:
a. the Bank Holding Company Act of 1956
b. the Bank Merger Act of 1960
c. the Change in Bank Control Act of 1978
d. all of the above
Answer: d
Difficulty Level: Medium
Subject Heading: Federal Reserve Regulation
53. A central bank serves the nation:
a. as a source of consumer credit when otherwise not available
b. by regulating money supply growth
c. as a secondary source of funds for home financing
d. as the strong right arm of the U.S. Treasury
Answer: b
Difficulty Level: Medium
Subject Heading: Functions of Central Banks
54. The capital stock of each Federal Reserve Bank:
a. is owned by the Board of Governors of the Fed
b. can be used in an emergency to provide funds for the Fed
c. is owned by members of the individual Federal Reserve Banks
d. has been reserved for purchase of the U.S. Treasury
Answer: c
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
55. Which of the following statements is true when describing Federal Reserve Banks?
a. they are located in each of the 50 states
b. every Federal Reserve Bank has at least one branch
c. they have been moved from city to city as the U.S. developed
d. two Federal Reserve Banks are located in the same state
Answer: b
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
56. The Federal Reserve System consists of all of the following components EXCEPT:
a. Federal Reserve District Banks
b. Board of Governors
c. Federal Open Market Committee
d. all of the above
Answer: d
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
57. The Federal Reserve System consists of all of the following components EXCEPT:
a. Monetary Policy Committee
b. Board of Governors
c. Federal Open Market Committee
d. all of the above
Answer: a
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
58. The seven-member board of the Federal Reserve that sets monetary policy is called
a. the Federal Reserve Open Market Committee
b. the Federal Reserve Board of Governors
c. the Federal Reserve Advisory Committee
d. none of the above
Answer: b
Difficulty Level: Easy
Subject Heading: Structure of the Federal Reserve
59. Federal Reserve actions that offset unexpected monetary developments and contribute to the smooth everyday functioning of the economy are called
a. defensive actions
b. dynamic actions
c. accommodative actions
d. none of the above
Answer: a
Difficulty Level: Medium
Subject Heading: Federal Reserve Operations
60. The basic policy instruments that the Fed uses to execute monetary policy include all of the following EXCEPT
a. changing reserve requirements
b. changing the discount rate
c. conducting open market operations
d. all of the above are monetary policy instruments
Answer: d
Difficulty Level: Medium
Subject Heading: Monetary Policy
61. The basic policy instruments that the Fed uses to execute monetary policy include all of the following EXCEPT
a. changing reserve requirements
b. changing the discount rate
c. conducting closed market operations
d. all of the above are monetary policy instruments
Answer: c
Difficulty Level: Medium
Subject Heading: Monetary Policy
62. The percentage of deposits that must be held as reserves is called
a. the bank reserve percentage
b. the required reserve ratio
c. the excess reserve ratio
d. the fractional reserve percentage
Answer: b
Difficulty Level: Medium
Subject Heading: Federal Reserve Operations
63. The interest rate that a bank must pay to borrow from its regional federal reserve bank is called
a. the National Discount Rate
b. the Prime Rate
c. the Federal Discount Rate
d. none of the above
Answer: c
Difficulty Level: Medium
Subject Heading: Federal Reserve Operations
64. The most used monetary policy instrument used by the Fed is
a. open market operations
b. changing the discount rate
c. changing the reserve requirement
d. none of the above
Answer: a
Difficulty Level: Medium
Subject Heading: Monetary Policy
65. The least used monetary policy instrument used by the Fed is
a. open market operations
b. changing the discount rate
c. changing the reserve requirement
d. none of the above
Answer: c
Difficulty Level: Medium
Subject Heading: Monetary Policy
66. ____________________________ requires disclosure of the finance charge and the annual percentage rate of credit along with certain other costs and terms to permit consumers to compare the prices of credit from differing sources.
a. Truth in Lending Act
b. Equal Credit Opportunity Act
c. Federal Trade Commission Improvement Act
d. Fair Credit Billing Act
Answer: a
Difficulty Level: Medium
Subject Heading: Federal Reserve Legislation
67. ____________________________ sets up a procedure for the prompt correction of errors on a revolving charge account and prevents damage to credit ratings while a dispute is being settled.
a. Truth in Lending Act
b. Equal Credit Opportunity Act
c. Federal Trade Commission Improvement Act
d. Fair Credit Billing Act
Answer: d
Difficulty Level: Medium
Subject Heading: Federal Reserve Legislation
68. ____________________________ prohibits discrimination in the granting of credit on the basis of sex, marital status, race, color, religion, national origin, age, or receipt of public assistance.
a. Truth in Lending Act
b. Equal Credit Opportunity Act
c. Federal Trade Commission Improvement Act
d. Fair Credit Billing Act
Answer: b
Difficulty Level: Medium
Subject Heading: Federal Reserve Legislation
69. ____________________________ authorizes the Federal Reserve Board to unfair or deceptive acts or practices on the part of banks and to issue regulations to prohibit them.
a. Truth in Lending Act
b. Equal Credit Opportunity Act
c. Federal Trade Commission Improvement Act
d. Fair Credit Billing Act
Answer: c
Difficulty Level: Medium
Subject Heading: Federal Reserve Legislation
a 70. The ____________________________ conducts monetary policy for the twelve European countries that adopted the euro as their common currency.
a. European Central Bank
b. Switzerland Central Bank
c. London Central Bank
d. British National Bank
Answer: a
Difficulty Level: Easy
Subject Heading: International Central Banking
71. Currently, the Chairman of the Federal Reserve is ________________________.
a. Paul Volker
b. Alan Greenspan
c. Ben Bernanke
d. None of the above
Answer: c
Difficulty Level: Easy
Subject Heading: Structure of the Federal Reserve
72. In response to the 2007 - 2009 financial crisis, the Fed’s prime credit rate, which was 6.25 percent at the end of 2006, was lowered to _____ percent by the end of 2008 and was maintained at that level through 2009.
a. 0.0
b. 0.5
c. 1.0
d. 1.5
e. none of the above
Answer: b
Difficulty Level: Medium
Subject Heading: 2007-2009 Financial Crisis
73. The five components of the Federal Reserve System include:
a. Member banks, Federal Reserve District Banks, Board of Governors, Federal Open Market Committee, Adlib Committees.
b. Nonmember banks, Federal Reserve District Banks, Board of Governors, Federal Open Market Committee, Advisory committees.
c. Member banks, Federal Reserve District Banks, Board of Governors, Federal Open Market Committee, Advisory committees.
d. Member banks, Federal Reserve District Banks, Board of Governors, Federal Closed Market Committee, Advisory committees.
e. none of the above
Answer: c
Difficulty Level: Hard
Subject Heading: Structure of the Federal Reserve
74. The five components of the Federal Reserve System include:
a. Member banks, Federal Reserve District Banks, Board of Governors, Federal Open Market Committee, Adlib Committees.
b. Nonmember banks, Federal Reserve District Banks, Board of Governors, Federal Open Market Committee, Advisory committees.
c. Member banks, Federal Reserve District Banks, Board of Presidents, Federal Open Market Committee, Advisory committees.
d. Member banks, Federal Reserve District Banks, Board of Governors, Federal Closed Market Committee, Advisory committees.
e. none of the above
Answer: e
Difficulty Level: Hard
Subject Heading: Structure of the Federal Reserve
75. Approximately __________ of the nation’s commercial banks are members of the Fed.
a. three-fourths
b. two-thirds.
c. one-third.
d. one-half.
e. none of the above
Answer: c
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
76. __________ directors of the Federal Reserve are appointed by the Board of Governors of the Federal Reserve System and may not be stockholders, directors, or employees of existing banks.
a. Class A
b. Class B
c. Class C
d. Class D
Answer: c
Difficulty Level: Hard
Subject Heading: Structure of the Federal Reserve
77. Although it enjoys substantial independence in its operations, the appointive power of the president and the ability of Congress to alter its structure make the ______________ a dependent political structure and one of the most powerful monetary organizations in the world.
a. Board of Governors (BOG)
b. Board of Directors (BOD)
c. Governing Body (GOB)
d. Financial Governors (FOG)
e. none of the above
Answer: a
Difficulty Level: Hard
Subject Heading: Structure of the Federal Reserve
78. Although it enjoys substantial independence in its operations, the appointive power of the president and the ability of Congress to alter its structure make the ______________ a dependent political structure and one of the most powerful monetary organizations in the world.
a. Presidential Appointment Board (PAB)
b. Board of Directors (BOD)
c. Governing Body (GOB)
d. Financial Governors (FOG)
e. none of the above
Answer: e
Difficulty Level: Hard
Subject Heading: Structure of the Federal Reserve
79. The Board of Governors of the Federal Reserve establishes monetary policy by:
a. setting reserve requirements, altering the prime rate, and through federal open market operations.
b. setting reserve requirements, altering the discount rate, and through federal open market operations.
c. setting reserve requirements, altering the discount rate, and through international currency transactions.
d. setting bank profitability ratios, altering the discount rate, and through federal open market operations.
e. none of the above
Answer: b
Difficulty Level: Hard
Subject Heading: Monetary Policy
80. The Board of Governors of the Federal Reserve establishes monetary policy by:
a. setting reserve requirements, altering the prime rate, and through federal open market operations.
b. setting loan to value ratios, altering the discount rate, and through federal open market operations.
c. setting reserve requirements, altering the discount rate, and through international currency transactions.
d. setting bank profitability ratios, altering the discount rate, and through federal open market operations.
e. none of the above
Answer: e
Difficulty Level: Hard
Subject Heading: Monetary Policy
81. Which of the following is not a method by which the Federal Reserve establishes monetary policy?
a. setting reserve requirements,
b. altering the discount rate,
c. through federal open market operations,
d. setting bank profitability ratios,
e. none of the above
Answer: d
Difficulty Level: Medium
Subject Heading: Monetary Policy
82. Which of the following is a method by which the Federal Reserve establishes monetary policy?
a. setting reserve requirements,
b. altering the discount rate,
c. through federal open market operations,
d. all of the above methods are used.
e. none of the above
Answer: d
Difficulty Level: Medium
Subject Heading: Monetary Policy
83. The Board of Governors publishes ________________, which carries articles of current interest and offers a convenient source of the statistics compiled by the Fed.
a. the Federal Reserve Magazine
b. the Federal Reserve Bulletin
c. the Federal Reserve Journal
d. the Federal Reserve News
e. none of the above
Answer: b
Difficulty Level: Medium
Subject Heading: Functions of the Federal Reserve
84. The Board of Governors publishes ________________, which carries articles of current interest and offers a convenient source of the statistics compiled by the Fed.
a. the Federal Reserve Magazine
b. the Federal Reserve Weekly
c. the Federal Reserve Journal
d. the Federal Reserve News
e. none of the above
Answer: e
Difficulty Level: Medium
Subject Heading: Functions of the Federal Reserve
85. History generally supports the contention that under the guidance of Paul Volcker, a (n) ____________ Fed policy brought down the double-digit inflation of the 1970s and the early 1980s, and the Federal Open Market Committee consistently responded to his leadership.
a. loosening of
b. restrictive
c. expansionary
d. two of the above
e. none of the above
Answer: b
Difficulty Level: Medium
Subject Heading: History of the Federal Reserve
e 86. History generally supports the contention that under the guidance of Paul Volcker, a (n) ____________ Fed policy brought down the double-digit inflation of the 1970s and the early 1980s, and the Federal Open Market Committee consistently responded to his leadership.
a. loosening of
b. easing of
c. expansionary
d. two of the above
e. none of the above
Answer: e
Difficulty Level: Medium
Subject Heading: History of the Federal Reserve
87. Alan Greenspan’s tenure as chair of the Fed Board was generally characterized by:
a. real economic decline in the U.S. economy, interest rates that declined to historic lows, and stock prices that reached all-time highs.
b. real economic growth in the U.S. economy, interest rates that rose to historic highs, and stock prices that reached all-time highs.
c. real economic growth in the U.S. economy, interest rates that declined to historic lows, and stock prices that reached all-time lows.
d. real economic growth in the U.S. economy, interest rates that declined to historic lows, and stock prices that reached all-time highs.
e. none of the above
Answer: d
Difficulty Level: Hard
Subject Heading: History of the Federal Reserve
88. Today the responsibilities of the Fed may be described as:
a. those relating to monetary policy, to supervision and regulation, and to services provided for depository institutions and the government.
b. those relating to fiscal policy, to supervision and regulation, and to services provided for depository institutions and the government.
c. those relating to monetary policy, to deregulation, and to services provided for depository institutions and the government.
d. those relating to monetary policy, to supervision and regulation, and to services provided for homeowners and the government.
e. none of the above
Answer: a
Difficulty Level: Hard
Subject Heading: Function of the Federal Reserve
89. Today the responsibilities of the Fed may be described as:
a. those relating to monetary and fiscal policy, to supervision and regulation, and to services provided for depository institutions and the government.
b. those relating to fiscal policy, to supervision and regulation, and to services provided for depository institutions and the government.
c. those relating to monetary policy, to deregulation, and to services provided for depository institutions and the government.
d. those relating to monetary policy, to supervision and regulation, and to services provided for homeowners and the government.
e. none of the above
Answer: e
Difficulty Level: Hard
Subject Heading: Function of the Federal Reserve
90. The banking system of the United States is a ___________ reserve system because banks are required by the Fed to hold reserves equal to a specified percentage of their deposits.
a. required
b. fractional
c. proportional
d. multiplicative
e. none of the above
Answer: b
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
91. Because depository institutions earn no interest on reserves:
a. profit maximizing behavior motivates them to lend out excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are high, this motivation is especially strong.
b. profit maximizing behavior motivates them to lend out excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are low, this motivation is especially strong.
c. profit maximizing behavior motivates them to retain excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are low, this motivation is especially strong.
d. profit maximizing behavior motivates them to retain excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are high, this motivation is especially strong.
e. none of the above
Answer: a
Difficulty Level: Hard
Subject Heading: Financial Institutions
92. Because depository institutions earn no interest on reserves:
a. profit maximizing behavior motivates them to retain excess reserves to the fullest extent consistent with their liquidity requirements; and when reserve requirements are low, this motivation is especially strong.
b. profit maximizing behavior motivates them to lend out excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are low, this motivation is especially strong.
c. profit maximizing behavior motivates them to retain excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are low, this motivation is especially strong.
d. profit maximizing behavior motivates them to retain excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are high, this motivation is especially strong.
e. none of the above
Answer: e
Difficulty Level: Hard
Subject Heading: Financial Institutions
93. __________________ become the most important and effective means of monetary and credit control.
a. Changing reserve requirements has
b. Changing the discount rate has
c. Open market operations has
d. Changing the Treasury bill rate has
e. none of the above
Answer: c
Difficulty Level: Medium
Subject Heading: Monetary Policy
94. Which of the following statements is most correct?
a. Open-market operations always lead to an immediate increase in the volume of lending; this is especially true when bonds are sold to restrict deposit growth.
b. Open-market operations don’t always lead to an immediate change in the volume of deposits; this is especially true when bonds are purchased to expand deposit growth.
c. Open-market operations always lead to an immediate change in the volume of deposits; this is especially true when bonds are sold to restrict deposit growth.
d. Open-market operations don’t always lead to an immediate change in the volume of deposits; this is especially true when bonds are sold to restrict deposit growth.
e. none of the above
Answer: d
Difficulty Level: Hard
Subject Heading: Monetary Policy
95. Which of the following statements is most correct?
a. Open-market operations always lead to an immediate increase in the volume of lending; this is especially true when bonds are sold to restrict deposit growth.
b. Open-market operations don’t always lead to an immediate change in the volume of deposits; this is especially true when bonds are purchased to expand deposit growth.
c. Open-market operations always lead to an immediate change in the volume of deposits; this is especially true when bonds are sold to restrict deposit growth.
d. Increasing reserve requirements always leads to an immediate increase in the volume of lending; this is especially true when bonds are sold to restrict deposit growth.
e. none of the above
Answer: e
Difficulty Level: Hard
Subject Heading: Monetary Policy
96. The __________________, passed in 1968, requires the clear explanation of consumer credit costs and garnishment procedures (taking wages or property by legal means) and prohibits overly high-priced credit transactions.
a. Consumer Credit Expansion Act
b. Credit Growth Act
c. Consumer Credit Protection Act
d. Consumer Safety Act
e. none of the above
Answer: c
Difficulty Level: Medium
Subject Heading: Federal Reserve Legislation
97. A (n) ____________________ is necessary for the monetary system to carry out the financial function of transferring money, which in turn is a requirement for an effective financial system.
a. internet banking system
b. electronic data transfer system
c. wire transfer system
d. efficient payments mechanism
e. none of the above
Answer: d
Difficulty Level: Medium
Subject Heading: Structure of Financial System
98. The central bank in the United Kingdom is the:
a. Bank of Britain
b. British Fed
c. British Bank
d. Bank of England
e. none of the above
Answer: c
Difficulty Level: Medium
Subject Heading: International Central Banking
99. The ___________________ conducts monetary policy for the twelve European countries that formed the European Monetary Union and adopted the euro as their common currency at the beginning of 1999.
a. Bank of England
b. European Central Bank
c. Bank of Europe
d. Bank of Switzerland
e. none of the above
Answer: b
Difficulty Level: Medium
Subject Heading: International Central Banking
100. The two routes of check clearance include the _____________ settlement, in which the transaction takes place entirely within a single Federal Reserve district, and the _____________ settlement, in which there are relationships between banks of two Federal Reserve districts.
a. interdistrict, intradistrict
b. intradistrict, interdistrict
c. Fed wire, District wire
d. District wire, Fed wire
e. none of the above
Answer: a
Difficulty Level: Medium
Subject Heading: Structure of the Federal Reserve
Chapter 2
Money and the Monetary System
CHAPTER PREVIEW
The monetary system plays an important role in the operation and development of the financial system. This chapter describes the monetary system of the United States in detail. We begin with a discussion of the process of moving savings into investments and follow with an overview of the monetary system. We then cover the three major functions of money and how money developed in the U.S. over time. Next, we cover money market securities and follow with measures of the U.S. money supply. This is followed by a brief presentation of the views of monetarists and Keynesians concerning the relationship between the money supply and economic activity. The chapter concludes with a brief coverage of the international monetary system.
LEARNING OBJECTIVES
· Describe the three ways that money is transferred from savers to investors.
· Identify the major components of the monetary system.
· Describe the functions of money.
· Give a brief review of the development of money in the U.S.
· Describe major types of money market securities.
· Briefly explain the M1, M2, and M3 definitions of the money supply.
· Explain possible relationships between money supply and economic activity.
· Comment on developments in the international monetary system.
CHAPTER OUTLINE
I. PROCESS OF MOVING SAVINGS INTO INVESTMENTS
II. OVERVIEW OF THE MONETARY SYSTEM
III. IMPORTANCE AND FUNCTIONS OF MONEY
IV. DEVELOPMENT OF MONEY IN THE UNITED STATES
A. Physical Money (Coin and Paper Currency)
1. U.S. Coins
2. Paper Currency
B. Deposit Money
V. MONEY MARKET SECURITIES
VI. MEASURES OF THE U.S. MONEY SUPPLY
A. M1 Money Supply
B. M2 Money Supply
C. M3 Money Supply
D. Exclusions from the Money Supply
VII. MONEY SUPPLY AND ECONOMIC ACTIVITY
VIII. INTERNATIONAL MONETARY SYSTEM
IX. SUMMARY
LECTURE NOTES
I. PROCESS OF MOVING SAVINGS INTO INVESTMENTS
We begin with a discussion of the difference between a surplus economic unit and a deficit economic unit. We focus on the savings-investment process that involves the direct or indirect transfer of individual savings to business firms in exchange for their debt securities. Savers may invest directly in a business firm by exchanging their money for the firm’s securities. Savers also may make indirect transfers by first placing their money either through an investment banking firm or a financial intermediary. When using an investment banking firm, money flows from savers through to the business firm and the business firm’s securities flow back through to the savers. When using a financial intermediary, savers invest their money in a financial institution and receive the institution’s securities. The financial institutions then invest money in the business firm and receive the firm’s securities in exchange for their investment.
(Use Figure 2.1 and Discussion Questions 1 through 3 here.)
II. OVERVIEW OF THE MONETARY SYSTEM
The monetary system is responsible for carrying out the financial functions of creating and transferring money. Money is transferred from savers to investors either directly or indirectly. For example, if the investor is a business firm, a direct transfer takes place when savers purchase the securities (stocks or debt instruments) of the business firm by exchanging money for the firm’s securities.
An indirect transfer between savers and a business firm can take place either through an investment banking firm or through a financial intermediary. Investment banking firms often first purchase the securities from the issuing firm and then sell the securities to the savers. However, no additional securities are created in this type of indirect transfer. When using a financial intermediary, savers deposit or invest money with a financial intermediary such as a bank which issues its own securities to the saver. The bank, in turn, makes a loan to the business firm.
The major participants in the U.S. monetary system include a central bank and a banking system comprised of a number of individual banks. The Federal Reserve System is the central bank in the U.S. and it is responsible for defining and regulating the money supply, as well as facilitating the transferring of money through check processing and clearing. The banking system creates money and transfers money through check processing and clearing within the banking system.
(Use Figure 2.2 and Discussion Question 4 here.)
iii. IMPORTANCE AND FUNCTIONS OF MONEY
We begin with a discussion of the difference between real and financial assets. Money is anything generally accepted as a means of paying for goods and services and for paying off debts. The basic function of money is that of serving as a medium of exchange. A second function of money is that it can be held as a store of value (or purchasing power) and thus can be drawn upon at will. Money is perfectly liquid since it is a generally accepted medium of exchange. Money also serves as a standard of value. This third function refers to the fact that prices as well as contracts for deferred payments are expressed in terms of the monetary unit.
(Use Discussion Questions 5 through 7 here.)
Iv. DEVELOPMENT OF MONEY in the uNITED STATES
The U.S. monetary system developed to meet the changing needs of the economy. As primitive economies began to develop, a barter system (based on tables of relative values) was developed to help facilitate the exchange of goods and services. Records in early economies show many items that were useful for food or clothing (i.e., commodities) were used as both a medium of exchange and as a unit for measuring value.
There was a gradual transition from the use of commodities for exchange to the use of precious metals. The advantages of precious metals eventually led to their general use. For example, the supply of gold and silver was limited enough so that these metals had great value, and they were also in great demand for ornamentation purposes. Coins with a certain weight of metal in them were developed to aid the process of exchanging goods and services.
Full-bodied money is used to refer to coins that have metal content worth the same as their face values. Coins with face values higher than the value of their metal content are called token coins. Paper money may be either representative full-bodied money or fiat money. Representative full-bodied money is paper money that is backed by an amount of precious metal equal in value to the face amount of the paper money. Fiat money is money that is not backed by precious metals but is decreed by the government to be “legal tender” for purposes of making payments and discharging debts.
The use of physical money (coin and currency) to complete transactions can be very costly and inefficient. As a result, along with confidence in the banking system, a special type of credit money called deposit money has grown in importance. Credit money is money backed by the “creditworthiness” of the issuer. Deposit money is backed by the creditworthiness of the depository institution that issued the deposit.
Automatic transfer service (ATS) accounts provide for direct deposits to, and payments from checkable deposit accounts. Employers can have their employees’ wages deposited directly in their checking accounts. Individuals can have regular payments such as mortgage payments automatically deducted from their accounts. Debit cards provide for immediate direct transfer of deposit amounts such as when a debit card is used to purchase merchandise at a retailer’s “point of sale” cash register. When the sale is recorded, the cardholder’s bank transfers the designated amount from the purchaser’s demand account to the retailer’s account.
(Use Figures 2.3, 2.4, and 2.5 and Discussion Questions 8 through 13 here.)
V. MONEY MARKET SECURITIES
Money market securities are debt instruments or securities with maturities of one year or less that are created or trade in money markets. We identify six major money market securities: a) treasury bills, b) commercial paper, c) negotiable certificates of deposit (negotiable CDs), e) repurchase agreements, and f) federal funds.
(Use Figure 2.6 and Discussion Question 14 here.)
VI. U.S. MONEY SUPPLY today
The M1 definition of the money supply includes only types of money that are acceptable as a medium of exchange. Included are currency, traveler’s checks, demand deposits, and other checkable deposits. All four components are types of credit money. The coins are token money and the paper currency is fiat money in the form of Federal Reserve Notes.
M2 is a broader measure of the money supply than M1 because it emphasizes money as a store of value in addition to its function as a medium of exchange. M2 includes all of M1 plus savings deposits, money market deposit accounts (MMDAs), and small-denomination time deposits (under $100,000) at depository institutions plus balance in retail money market mutual funds (MMMFs) where initial investments are less than $50,000.
M3 takes an even broader view of money as a store of value. M3 includes all of M2 plus large time deposits (over $100,000), balances in institutional MMMFs (minimum initial investment of $50,000 or more), repurchase agreements (overnight and term) issued by depository institutions, and Eurodollars (overnight and term) held by U.S. residents in the United Kingdom and Canada and at foreign branches of U.S. banks.
(Use Figure 2.7 and Discussion Questions 15 through 17 here.)
VII. MONEY SUPPLY AND ECONOMIC ACTIVITY
Economists generally believe that money supply “matters” when trying to “manage” economic activity. They have observed that economic activity, money supply, and the price levels of goods and services generally move together over time. However, economists disagree as to how these relationships are to be explained.
Monetarists believe that the amount of money in circulation determines the level of gross domestic product (GDP) or economic activity. If we divide GDP by the money supply (MS), we get the number of times the money supply “turns over” to produce GDP. This turnover of money is called the velocity of money and measures the rate of circulation of the money supply. Monetarists also believe that when the money supply exceeds the amount of money demanded, the public will spend more rapidly causing real economic activity or prices to rise. A too rapid rate of growth in the money supply will ultimately result in rising prices or inflation because excess money will be used to bid up the prices of existing goods.
Other economists, called Keynesians, believe that a change in the money supply has a less direct relationship with GDP. They argue that a change in money supply first causes a change in interest rate levels which, in turn, alters the demand for goods and services. Decreases in the money supply will likely cause interest rates to rise. As a result, GDP will grow more slowly or even decline depending on how the higher interest rates affect consumption and spending decisions.
(Use Discussion Questions 18 and 19 here.)
VIII. INTERNATIONAL MONETARY SYSTEM
Students should be made aware of the globalization of economic activity. The exchange of goods and services is no longer primarily within the borders of an individual country. Rather, a country’s economic system is necessarily tied to the international exchange of goods and services. A well developed international monetary system is necessary for a successful global economy.
The international monetary system has been historically tied to the gold standard. For example, in 1944 many of the world’s economic powers met and agreed to an international monetary system that was tied to the U.S. dollar or gold via fixed, or pegged, exchange rates. By early 1973, major currencies were allowed to “float” against each other, resulting in a flexible or floating exchange rate system. Today the current international monetary system is a “managed” floating exchange rate system (because central monetary authorities sometimes intervene).
A currency exchange rate indicates the value of one currency relative to another. If demand for a particularly currency falls relative to its supply, the exchange rate falls and the international purchasing power of that nation’s money supply drops. We discuss currency exchange rates in detail in Chapter 6.
(Use Discussion Question 20 here.)
DISCUSSION Questions AND ANSWERS
1. How do surplus economic units and deficit economic units differ?
A surplus economic unit generates more money than it spends resulting in excess money to save or spend.
A deficit economic unit spends more money than it brings in resulting in a need for additional money.
2. Describe the three basic ways whereby money is transferred from savers to investors.
There can be a direct transfer of money between savers and investors. For example, savers can directly purchase the stocks or debt instruments of a business firm by exchanging money for the firm’s securities. Money also can be transferred from savers to investors via indirect transfers. For example, if the investor is a business firm, savers can transfer money to the business firm either through the use of an investment banking firm or through a financial intermediary.
3. Identify economic units in addition to business firms who might need funds from savers.
Government entities (U.S. government and state and local governments) spending more than their tax revenues may need funds from savers to balance their budgets. Some individuals and other units might seek funds from savers to finance home ownership or other real estate investments.
4. Identify the major participants in the U.S. monetary system.
A central bank (i.e., the Federal Reserve System in the U.S.) is needed to define and regulate money supply and to facilitate the transferring of money through check processing and clearing. An efficient banking system also is needed to create money, transfer money, provide financial intermediation, and to process and clear checks.
5. Indicate how real assets and financial assets differ.
Real assets include the direct ownership of land, buildings, homes, equipment, inventories, durable goods, and precious metals.
Financial assets include money, debt instruments, equity securities, and other financial contracts backed by real assets and the earning abilities of issuers.
6. Define money and indicate the basic functions of money.
Money acts as: (a) a medium of exchange; (b) a store of value; and (c) a standard of value. Unless the value of money is relatively stable, it will not be held long enough to serve as a medium of exchange or as a store of value or purchasing power. It can serve as a standard of value only if its value is relatively stable, since it is all but impossible to use a varying standard for measuring values.
7. Describe how an individual’s net worth is determined.
Individual net worth is the sum of an individual’s money, real assets, and financial assets or claims against others less the individual’s debt obligations.
8. Briefly describe the development of money, from barter to the use of precious metals.
Barter, or the exchange of goods for goods, developed as specialization of production and exchange of goods developed. Some items were generally desired and other goods were traded for them since they could always be used for further trading. The goods that were frequently traded also served as a yardstick for measuring the value of goods traded less frequently. However, barter was clumsy because items of food, clothing, and ornamentation were difficult to carry around; items were of different quality, so arguments could arise over their value.
Exchange was also clumsy since it had to take place in whole units, such as one or two furs, and the like. The use of gold and silver did not present these difficulties, and so they became more widely used. As time went on, these metals were made into coins with definite weights in metals of a certain purity, and they served even more effectively as a medium of exchange.
9. What is the difference between full-bodied money and token coins?
Full-bodied money is defined as coins that have metal content equal to their face values. Toke coins are coins with face values higher than the values of their metal content.
10. Describe how representative full-bodied money and fiat money differ.
Representative full-bodied money is paper money that is backed by an amount of precious metal equal in value to the face amount of the paper money. Fiat money is paper money without metal backing but where the government decrees the money to be “legal tender” for purposes of making payments and discharging public and private debts.
11. What is deposit money and how is it “backed”?
Credit money is money backed by the “creditworthiness” of the issuer. Deposit money is backed by the creditworthiness of the depository institution that issued the deposit.
12. What are automatic transfer service (ATS) accounts?
ATS accounts provide for direct deposits to, and payments from, checkable deposit accounts. For example, employers can have their employees’ wages deposited directly in their checking accounts instead of issuing payroll checks.
13. What are debit cards and how are they used?
Debit cards provide for the immediate direct transfer of deposit amounts. For example, when a debit card is used to purchase merchandise at a retailer’s “point of sale” cash register, the card holder’s bank transfers the designated amount form the purchaser’s demand account to the retailer’s account.
14. Define money market securities and briefly describe the major types of these securities.
Money market securities are debt instruments or securities with maturities of one year or less. We identify six major money market securities:
Treasury bills short-term debt obligations issued by the U.S. federal government.
Negotiable certificates of deposit (negotiable CDs) are short-term debt instruments issued by depository institutions that can be traded in secondary money markets.
Commercial paper is short-term unsecured promissory notes issued by high credit-quality corporations.
Banker’s Acceptances are promises of future payment issued by importing firms and guaranteed by banks.
Repurchase agreements are short-term debt securities where sellers agree to repurchase their securities at a specified price and date.
Federal funds are very short-term loans between depository institutions with excess funds and those with a need for funds.
15. Describe the M1 definition of the money supply and indicate the relative significance of the M1 components.
M1 includes: currency (coin and federal reserve notes), demand deposits at commercial banks and other checkable deposits at depository institutions (commercial banks, savings and loan associations, savings banks, and credit unions), and travelers checks. Currency and demand deposits are the two largest components of M1 and together account for over three-fourths of M1. Traveler’s checks represent less than one percent of M1.
M1 measures transaction balances which are sums of money that can be spent without first converting them to some other asset, and which are held for anticipated or unanticipated purchases or payments in the immediate future. Essentially, only those amounts that represent the purchasing power of units in our economy other than the federal government are counted.
16. How does M2 differ from M1? What are money market mutual funds?
M2 is a broader measure of the money supply than M1 because it emphasizes money as a store of value in addition to its function as a medium of exchange. M2 includes all of M1 plus savings deposits, money market deposit accounts (MMDAs), and small-denomination time deposits (under $100,000) at depository institutions plus balance in retail money market mutual funds (MMMFs) where initial investments are less than $50,000.
Money market mutual funds (MMMFs) issue “shares” to customers and invest the proceeds in highly liquid, very short maturity, interest-bearing debt instruments called “money market investments.” Thus, MMMFs get their name from the type of investments they make.
17. Describe the M3 measure of the money supply.
M3 takes an even broader view of money as a store of value. M3 includes all of M2 plus large time deposits (over $100,000), balances in institutional MMMFs (minimum initial investment of $50,000 or more), repurchase agreements (overnight and term) issued by depository institutions, and Eurodollars (overnight and term) held by U.S. residents in the United Kingdom and Canada and at foreign branches of U.S. banks.
18. Briefly describe the monetarists’ view of the relationship between money supply and economic activity.
Monetarists believe that the amount of money in circulation determines the level of GDP or economic activity. If we divide GDP by the money supply, we get the number of times the money supply turns over to produce GDP. This turnover of money is called the velocity of money. Monetarists also believe that when the money supply exceeds the amount of money demanded, the public will spend more rapidly causing real economic activity or prices to rise.
19. How do Keynesians view the relationship between money supply and economic activity?
Keynesians believe that a change in the money supply has a less direct relationship with GDP. They argue that a change in money supply first causes as change in interest rate levels which, in turn, alters the demand for goods and services. For example, an increase in the money supply might cause interest rates to fall (at least initially) because more money is being supplied relative to that being demanded.
20. Briefly describe the development of the international monetary system.
The international monetary system was historically tied to the gold standard. A breakdown in the gold standard occurred during World War I, and less formal exchange systems continued during the 1930s and during World War II. In 1944, many of the world’s economic powers met and agreed to an international monetary system which was tied to the U.S. dollar or gold via fixed or pegged exchange rates. By early 1973, major currencies were allowed to “float” against each other resulting in a flexible or floating exchange rate system. The current international monetary system is a “managed” (because sometimes central monetary authorities attempt to intervene) floating exchange rate system.
EXERCISES and answers
1. Match the following money market securities with their issuers.
Securities Issuers
a. Treasury bills [# 2] 1. depository institutions
b. negotiable CDs [#1] 2. U.S. government
c. commercial paper [#4] 3. banks
d. banker’s acceptances [#3] 4. business firms and institutions
2. Match the following money market securities with the level of secondary market activity.
a. Treasury bills [#4] 1. no activity
b. commercial paper [#3] 2. low activity
c. federal funds [#1] 3. moderate activity
d. negotiable CDs [#2] 4. high activity
3. Go to the Website of the Federal Reserve Bank of St. Louis at http://www.stlouisfed.org. Go to “research and data” and access the Federal Reserve Economic Database (FRED). Compare the present size of M1 and M2 money stock measures with the data presented in Figure 2.7. Also find the current sizes of these M1 components: currency, travelers’ checks, demand deposits, and other checkable deposits. Express each component as a percentage of M1 and compare your percentages with those presented in the Measures of the U.S. Money Supply section of this chapter.
The instructor should specify a recent month and ask students to find M1 and M2 for that month and compare their findings with data in Figure 2.7. While it takes some effort, each of the four components of M1 also can be found for the specified month for comparison with data in Figure 2.7.
4. Find several recent issues of Business Week. Identify articles relating to developments in the U.S. monetary system. Also search for possible developments occurring in foreign monetary systems.
Note: The former Business Week is now Bloomberg Businessweek.
The instructor can either (1) allow students flexibility in identifying and discussing relevant articles, or (2) identify one or more specific articles for students to discuss from recent issues of Bloomberg Businessweek.
5. We are faced with ethics decisions involving money almost every day. For example, we all probably have seen money in the form of coin or currency lying on the ground or floor somewhere. We also may have at some time discovered a lost wallet. Should it matter if the amount of money is small or large? Should it matter if no one else is around and/or there is no evidence of who lost the money? Sometimes we hear the finders-keepers argument being used to rationalize an individual’s decision. How would you react to the following scenarios?
a. You are walking down a street and find a dollar bill lying on the ground. No one else is close by. You consider picking up the dollar, acknowledging your good luck, and putting it in your pocket. What would you do?
Ethical behavior reflects how an individual treats others legally, fairly, and honestly. It is illegal to take another person’s money without earning it or having it given to you by that person. Of course, in some instances it is not known to whom the money belongs. Furthermore, when the amount of money is in the form of a coin or dollar bill found on the street, many individuals employ the “finders-keepers” argument—possibly in part because the effort to find the owner is more than the amount found. This is not to say that the act is ethical but rather seems to represent “practice” for many individuals.
b. While you are shopping in a grocery store you see a wallet lying on the floor. You don’t know who dropped the wallet. You consider holding on to the wallet until you get home and then search for the owner’s identification so that you might contact the owner with information that you have the wallet. Alternatively, you could just give the wallet to the store manager. What would you do?
Probably every individual would like to be treated fairly and honestly by others. Surely, if you “lost” your wallet, you would hope that it is turned in as soon as possible. Protecting your identity and credit cards is probably at least important as getting back the currency in your wallet. Furthermore, once you discovered you lost your wallet, you likely would retrace your steps including asking the store manager whether your wallet had been turned in.
Turning in the wallet as soon as you found it also would eliminate any enticement to keep what is not yours if you wait until you returned home and then made an effort to identify the owner.
PROBLEMS AND ANSWERS
1. Determine the size of the M1 money supply using the following information.
Currency plus Traveler’s checks $25 million
Negotiable CDs $10 million
Demand deposits $13 million
Other checkable deposits $12 million
The M1 money supply would be: $25 million (currency plus Traveler’s checks)) + $13 million (demand deposits) + $12 million (other checkable deposits) = $50 million.
2. Determine the size of the M1 money supply using the following information.
Currency $700 billion
Money market mutual funds $2,000 billion
Demand deposits $300 billion
Other checkable deposits $300 billion
Traveler’s checks $10 billion
3. Determine the size of the demand deposits component of the M1 money supply using the following information.
Currency $350 million
Traveler’s checks $10 million
Other checkable deposits $200 million
Small time deposits $100 million
M1 money supply $800 million
The demand deposits component would be: $800 million (M1 money supply) - $350 million (currency) - $10 million (traveler’s checks) -$200 million (other checkable deposits) = $240 million.
4. Following are components of the M1 money supply at the end of last year. What will be the size of the M1 money supply at the end of next year if currency grows by 10 percent, demand deposits grow by 5 percent, other checkable deposits grow by 8 percent, and the amount of traveler’s checks stays the same?
Currency $700 billion
Demand deposits $300 billion
Other checkable deposits $300 billion
Traveler’s checks $10 billion
Next year’s M1 would be: $700(1.10) billion + $300(1.05) billion + $300(1.08) billion + $10(1.00) billion = $770 billion + $315 billion + $324 billion + $10 billion = $1,419 billion.
5. The following information is available to you: travelers checks = $1 million; coin and paper currency = $30 million; repurchase agreements and Eurodollars = $15 million; demand deposits = $25 million; retail money market mutual funds = $60 million; savings accounts at depository institutions = $40 million; checkable deposits at depository institutions = $35 million; large-denomination time deposits = $50 million; institutional money market mutual funds = $65 million; and small-denomination time deposits = $45 million. Using Fed definitions, determine the dollar sizes of:
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