FINAN 4300 Problem Set 2

Money serves as a medium of exchange, store of value, and unit of account.

TRUE

Money is: medium of exchange, store of value, and unit of account. These roles distinguish it from other assets like stocks or commodities.

Wealth and income are two other terms for money.

FALSE

Wealth is the stock of assets owned,

Income is the flow earned over time.

Commodity money works only when societies agree on the value of the underlying good.

TRUE

Commodity money requires social consensus on the value of the underlying item. Without agreement, it cannot function reliably in trade.

Gold disappeared entirely as a monetary standard during the 1800s.

FALSE

Gold did not disappear as a standard in the 1800s; instead, it became more institutionalized through the international gold standard. Nations maintained convertibility well into the 20th century

Fiat money has no intrinsic value but relies on trust in the issuing government.

TRUE

Fiat money derives its value from trust in the issuing authority. Its stability rests on confidence in government and institutions.

Historically, over-issuance of fiat money (e.g., Continentals in 1775, Confederate

dollars in 1862) quickly eroded trust in that currency.

TRUE

Over-issuance of Continentals and Confederate dollars caused rapid depreciation. The lack of confidence destroyed their use as reliable money

According to the quantity theory of money, if velocity and transactions are stable,

an increase in the money supply will lead to higher prices.

TRUE

The quantity theory 𝑀𝑉 = 𝑃𝑇 shows that if velocity and transactions are stable, more money in circulation leads to higher prices. This highlights the link between money supply and inflation.

Goldsmiths in the Middle Ages only kept gold safe; they did not lend it out.

FALSE

Goldsmiths began by offering safekeeping but soon realized they could lend deposits profitably. This lending function was an early stage of modern banking.

Lending out a portion of deposited gold led to the origins of the money multiplier.

TRUE

By lending out part of deposits while keeping reserves, goldsmiths created more claims than gold on hand. This practice laid the foundation for the money multiplier.

The word “bankruptcy” comes from the Italian practice of smashing a defaulting

banker’s bench (banca rupta)

TRUE

The term “bankruptcy” comes from banca rupta—the broken bench of a failed banker in Renaissance Italy. It symbolized the end of their ability to trade

The Medici Bank (1397–1494) pioneered practices like double-entry bookkeeping and letters of credit.

TRUE

The Medici Bank pioneered these to support trade. These practices shaped modern banking infrastructure.

Banking families expanded across Europe to facilitate cross-border payments, trade, and even financing wars.

TRUE

Banking families like the Fuggers and Medicis built networks across Europe. They facilitated trade, enabled cross-border payments, and even financed wars and monarchies.

The steam engine was a key invention that increased capital demand and pushed banks toward financing industry instead of just wars and trade.

TRUE

Industrialization, symbolized by the steam engine, increased capital demand. Banks shifted toward financing factories and infrastructure, not just trade and war.

The rise of joint-stock banks during the Industrial Revolution allowed pooling of

capital from many shareholders to finance large projects

TRUE

Joint-stock banks allowed many shareholders to pool resources, funding railways and industrial enterprises. This broadened banking beyond family-owned institutions.

The First Bank of the United States (1791–1811) was an attempt at a national commercial bank, not a central bank.

TRUE

The First Bank of the U.S. operated as a national commercial bank, handling government finances and lending

During the Free Banking Era (1837–1863), thousands of state-chartered banks each issued their own notes, often trusted only locally

TRUE

Trust in these notes was often local and fragile, contributing to instability.

The National Banking Acts of the 1860s created the Federal Reserve System.

FALSE

The National Banking Acts created nationally chartered banks and a uniform national currency. The Federal Reserve was established in 1913.

Compared to Europe’s more centralized banking systems, the U.S. developed a fragmented structure of local banks, which contributed to instability in the 19th century

TRUE

Unlike Europe’s centralized systems, the U.S. developed fragmented local banking. This lack of integration contributed to frequent panics and instability.

The Panic of 1907, marked by widespread insurance fraud, was the final straw that led directly to the creation of the Federal Reserve in 1913.

FALSE

The Panic of 1907 was driven by trust company runs and bank panics, NOT insurance fraud. These runs revealed systemic fragility and spurred the creation of the Federal Reserve.

The FDIC (1933) was created to restore depositor trust by insuring deposits after

massive bank failures in the Great Depression.

TRUE

This measure restored confidence after massive bank failures during the Depression.

The Glass–Steagall Act of 1933 separated commercial banking from investment banking.

TRUE

Its goal was to reduce conflicts of interest and risk concentration.

The 2008 financial crisis demonstrated that U.S. banks had become “too big to fail,” leading to re-regulation under the Dodd–Frank Act (2010).

TRUE

The 2008 crisis showed that the failure of very large banks threatened the entire financial system. The Act responded with tighter regulation and oversight.

The failures of early fiat currencies (e.g., Continentals, Confederate dollars) prove

that fiat money can never be a stable store of value.

UNCERTAIN

Modern fiat (e.g., the U.S. dollar, euro) has remained stable when backed by strong institutions. Stability depends on governance and policy, not fiat’s nature alone.

A commercial bank’s success depends not only on its basic functions (taking deposits, making loans, offering payment services) but also on the three pillars of trust, legitimacy, and adaptation.

TRUE

Beyond core functions, banks must maintain these three values. These pillars sustain long-term survival in competitive environments

Trust is the most essential requirement for banking; without it, no deposit-taking or

lending system can function for long.

TRUE

Without confidence, depositors withdraw funds, leading to systemic collapse.