Chapter 29 - Money and the Banking System

if depositors become worried about the safety of their deposit accounts, they may trigger a
a. deposit surplus.
b. bank run.
c. fiscal policy crisis.
d. required reserve increase.

b. bank run.

The banking industry is heavily regulated because
a. banking is a monopoly industry.
b. most banks are owned by government agencies.
c. bankers do what is best for their stockholders, not necessarily what is best for the economy.
d. All of the above are correct.

c. bankers do what is best for their stockholders, not necessarily what is best for the economy.

Bankers' business decisions effect the money supply because bankers
a. are respected men and women.
b. have the ability to create money.
c. use a special accounting system developed by the Federal Reserve Board.
d. All of the above are correct.

b. have the ability to create money.

In order for barter trades to occur, there must be a
a. singularity of interests.
b. bargaining intermediary.
c. double coincidence of wants.
d. sufficient supply of cash.

c. double coincidence of wants.

The "efficiency of the payments mechanism" refers to
a. the ease and speed of exchanging money for goods and services.
b. how fast member banks replenish required reserves.
c. how fast banks pay interest on deposit accounts.
d. how fast countries pay off foreign debts.

a. the ease and speed of exchanging money for goods and services.

The primary benefit of a monetary system of exchange compared to a barter system is the increased
a. ability to record transactions.
b. time necessary to find trading partners.
c. time devoted to shopping.
d. efficiency in arranging transactions.

d. efficiency in arranging transactions.

Money is an imperfect store of value when
a. the rate of inflation is high.
b. the unemployment rate is high.
c. gold prices are falling.
d. businesses are failing due to bankruptcy.

a. the rate of inflation is high.

Liquidity refers to the
a. rapidity with which money flows through the economy.
b. ease with which an asset can be converted into cash.
c. ease with which banks move funds from checking to savings accounts.
d. All of the above are correct.

b. ease with which an asset can be converted into cash.

The primary feature of money is that it serves as
a. barter value.
b. a medium of exchange.
c. intrinsic value.
d. commodity value.

b. a medium of exchange.

The concept of money as a "unit of account" involves the use of money to
a. speed transactions.
b. reduce shopping time.
c. protect against inflation.
d. quote prices.

d. quote prices.

If fears of a terrorist attack are widespread and people lose faith in money, the economy could revert to a system of
a. cash and checks.
b. double-entry bookkeeping.
c. barter.
d. financial intermediaries.

c. barter.

Paper money in the United States is
a. backed by gold in Fort Knox.
b. partially backed by gold and silver.
c. entirely fiat money.
d. fully convertible into gold at fixed prices.

c. entirely fiat money.

Currently in the United States, money is backed by
a. silver in the IMF vaults.
b. Federal Reserve notes in banks.
c. gold in Fort Knox.
d. everyone's willingness to accept it.

d. everyone's willingness to accept it.

The one disadvantage of paper money is that it is easier to
a. duplicate and counterfeit.
b. carry.
c. divide.
d. store and use at a later time.

a. duplicate and counterfeit.

In comparison to commodity money, paper money
a. is not portable.
b. has no intrinsic value.
c. is not divisible.
d. cannot be stored.
e. All of the above are correct.

b. has no intrinsic value.

Fiat money is money
a. backed by land.
b. backed by gold or silver.
c. that can be converted to gold or silver.
d. because a government says it is.

d. because a government says it is.

Fiat money has value because it
a. is backed by gold.
b. can be used to buy goods and services.
c. can be exchanged for precious metals at a fixed price.
d. can be divided into smaller units.
e. All of the above are correct.

b. can be used to buy goods and services.

On the Micronesian island of Yap, the money that is primarily used as currency is
a. paper money.
b. wheels made of stone.
c. gold.
d. shells and gems.

b. wheels made of stone.

Which of the following observations is not true?
a. Money is divisible.
b. The value of money never remains the same.
c. Money has an intrinsic value.
d. Money is the most liquid form of asset.

c. Money has an intrinsic value.

Price levels rarely remain the same. This implies that
a. money is an excellent medium of exchange.
b. money is divisible.
c. money is a good medium for measuring value.
d. money is an imperfect medium for storing value.

d. money is an imperfect medium for storing value.

Which of the following definitions of the money supply includes only the most liquid forms of money?
a. M1
b. M2
c. savings deposits.
d. money market mutual deposits.

a. M1

Which of the following definitions of the money supply is the least liquid?
a. M1
b. M2
c. M3
d. L

d. L

"Near monies" are
a. stocks, bonds, and real estate.
b. U.S. notes and Federal Reserve notes.
c. included in the M1 definition of the money supply.
d. liquid assets that are close substitutes for money.
e. All of the above are correct.

d. liquid assets that are close substitutes for money.

One difference between the assets included in M1 and those added to calculate M2 is that items in M1 are
a. better stores of value than those added to compute M2.
b. more liquid than those added to compute M2.
c. less liquid than those added to compute M2.
d. larger than those added to compute M2.

b. more liquid than those added to compute M2.

The narrowest definition of the money supply (M1) includes
a. cash and travelers' checks.
b. cash, travelers' checks, and savings account balances.
c. cash, checking account balances, and travelers' checks.
d. cash, bank deposits, and money market accounts.

c. cash, checking account balances, and travelers' checks.

One conceptual problem in assigning assets to M1, M2, etc. is
a. distinguishing money from "near monies."
b. the problem of measuring asset size.
c. the need to agree on a unit of account.
d. the different size of financial assets.

a. distinguishing money from "near monies."

Why are checking account balances included in the M1 definition of the money supply?
a. They are a traditional form of money that pre-dates paper money.
b. They are used to make so many payments.
c. They are backed by gold and silver.
d. They pay interest.

b. They are used to make so many payments.

Although checking deposits are considered money, they are actually
a. fictitious numbers in persons' checkbooks.
b. backed by commodities like gold.
c. not very useful for making payments.
d. bookkeeping entries in bank balance sheets.

d. bookkeeping entries in bank balance sheets.

The narrowest definition of the money supply, including cash and checking deposits, is known as
a. M0.
b. M1.
c. M payments.
d. currency.
e. real-value money.

b. M1.

The largest portion of the M1 money supply consists of
a. coins in circulation.
b. paper currency in circulation.
c. savings deposits at credit unions.
d. checkable deposits.

d. checkable deposits.

The M2 definition of the money supply is based on the concept that
a. M1 is a small number, and should be increased in size.
b. many types of deposits can be used as both payments and stores of value.
c. checking deposits are used for payments, and therefore, not part of M1.
d. cash is not used for the majority of payments.

b. many types of deposits can be used as both payments and stores of value.

As of December 2010+, the largest single component of M2 consists of
a. checkable deposits at banks.
b. cash, coins, and other currency.
c. savings deposits.
d. gold and silver in commodity accounts.

c. savings deposits.

A "near money" is an asset that can be
a. indistinguishable from commodity money.
b. spent easily.
c. a close substitute for money.
d. only issued by a bank.

c. a close substitute for money.

Liquidity can be defined as the
a. cash value of money.
b. value of money adjusted for inflation.
c. value of fiat money when used for spending.
d. ease with which an asset can be converted to a spendable asset.

d. ease with which an asset can be converted to a spendable asset.

Identify the basis on which you measure the liquidity of an asset.
a. Its value.
b. Its future earning potential.
c. Its convertibility into cash.
d. Its ability to act as a perfect store of value.

c. Its convertibility into cash.

The distinction between M1 and M2 is based on
a. portability-the ease with which an asset can be moved.
b. divisibility-the ease with which an asset can be used to make smaller payments.
c. liquidity-the ease with which an asset can be converted into cash.
d. storability-how long an asset will retain its value.

c. liquidity-the ease with which an asset can be converted into cash.

Are funds available on a credit card included in a definition of the money supply?
a. Yes, because these funds can be used to pay for goods and services.
b. Yes, because these funds are included in M2.
c. No, because these funds are hard to measure total credit card spending.
d. No, because these funds are not a store of value.

d. No, because these funds are not a store of value.

In which of the following monetary aggregates are Treasury Bills included?
a. M1 only
b. M2 only
c. both M1 and M2
d. neither M1 nor M2

d. neither M1 nor M2

Which of the following are not included in the M1 definition of the money supply?
a. cash and currency
b. checkable deposits
c. money market deposit accounts
d. All of the above are included.

c. money market deposit accounts

On which of the following assets are you most likely to earn interest income?
a. cash and currency
b. checkable deposits
c. money market deposit accounts
d. gold and other precious metals
e. All of the above are correct.

c. money market deposit accounts

A principal disadvantage of conventional checking accounts compared to money market mutual funds is that checking accounts
a. are less liquid.
b. often do not pay interest.
c. cannot be used as a store of value.
d. are not insured by deposit insurance.

b. often do not pay interest.

Many economists believe that savings accounts should be added to M1 because they
a. are larger in size than conventional checking accounts.
b. pay larger interest than checking accounts.
c. can be transferred quickly into checkable accounts.
d. are also insured by the federal government.

c. can be transferred quickly into checkable accounts.

Due to new methods of electronically transferring assets from savings accounts to checking accounts, many economists favor moving savings accounts from
a. M1 into M2.
b. M2 into M3.
c. M3 into M2.
d. M2 into M1.

d. M2 into M1.

According to the convention followed in the text, "money" consists all of the following except
a. coins.
b. credit cards.
c. checkable deposits.
d. paper money.

b. credit cards.

When banking first began, it could be said that paper money was in reality
a. worthless.
b. receipts.
c. government money.
d. fiat money.

b. receipts.

Fractional reserve banking began as a search for
a. a different metallic monetary system.
b. additional sources of gold.
c. different types of borrowers.
d. additional profits.

d. additional profits.

With the invention of banking, one important aspect of money was that
a. banks have some discretion over the money supply.
b. banks have complete control over the money supply.
c. governments lost all control over the money supply.
d. individuals have no discretion over the money supply.

a. banks have some discretion over the money supply.

The early goldsmiths issued money in the form of
a. coins made from gold in their safes.
b. receipts for the acceptance of gold deposits.
c. gold fragments left over from the production of jewelry.
d. fully backed gold certificates.

b. receipts for the acceptance of gold deposits.

The fractional reserve system of banking evolved because
a. goldsmiths did not have safes large enough to hold all their gold deposits.
b. there was always a dire need for additional money.
c. goldsmiths knew that on any given day, only a few depositors would come to claim their deposits.
d. goldsmiths knew that they would not be prosecuted for lending out money they did not have.

c. goldsmiths knew that on any given day, only a few depositors would come to claim their deposits.

The initial development of paper money began when people used \____ as payment for goods and services.
a. credit cards
b. commodity money
c. goldsmith receipts
d. gold bullion
e. gold coins

c. goldsmith receipts

Fractional reserve banking takes its name from the fact that banks
a. hold only a fraction of their reserves at the bank itself.
b. keep only a fraction of their total deposits on reserve.
c. lend only a fraction of their total reserves to customers.
d. reserve only a fraction of their activity for lending.

b. keep only a fraction of their total deposits on reserve.

An important effect of fractional reserve banking is that bankers have
a. little control over total reserves.
b. total control over the amount of lending in the economy.
c. no control over the amount of reserves in the banking system.
d. some discretion over the money supply.

d. some discretion over the money supply.

Under fractional banking, when a bank lends to a customer
a. the money supply increases.
b. bank profitability is decreased.
c. the bank is protected from a run.
d. bank credit decreases.

a. the money supply increases

If bankers decide to keep a lower fraction of deposits on reserve, the money supply will
a. decrease.
b. increase.
c. remain unchanged.
d. move more quickly through the economy.

b. increase.

Bank regulators are concerned about the safety of depositors because
a. bank failures were common throughout most of U.S. history and have even occurred in recent decades.
b. in the absence of federal insurance, depositors would lose their money if a bank failed.
c. nervous depositors may rush to withdraw their accounts and produce a "run" that could threaten even a sound bank.
d. All of the above are correct.

d. All of the above are correct.

The moral hazard problem refers to
a. difficulty banks have in satisfying the government's reserve requirement.
b. depositors making a run on the bank, even though the bank is insured.
c. banks taking on more risk in their lending because they know their depositors are insured.
d. banks issuing bank notes that compete with the government's currency.

c. banks taking on more risk in their lending because they know their depositors are insured.

The objective of bank management is to
a. maximize stockholders' profits by making risky investments and giving loans to borrowers who will pay the highest interest rates.
b. refuse to make risky loans and make loans only to the safest borrowers.
c. invest in U.S. government securities and make loans only to established businesses.
d. strike the appropriate balance between the attraction of bank profits and the need for bank safety.

d. strike the appropriate balance between the attraction of bank profits and the need for bank safety.

Excess reserves make a bank less vulnerable to runs, but bankers do not like to hold excess reserves because holding excess reserves
a. are disliked by depositors.
b. means lower profits for banks.
c. are discouraged by government regulators.
d. All of the above are correct.

b. means lower profits for banks.

Banking under a system of fractional reserves is a(n)
a. inherently risky business that is unsafe regardless of bank management.
b. inherently risky business that is relatively safe under prudent management.
c. fairly safe business unless management is irresponsible.
d. fairly safe business with no unusual risks.

b. inherently risky business that is relatively safe under prudent management.

Banks that are managed in a very safe and conservative manner can be expected to earn
a. high, steady profits.
b. high but volatile profits.
c. low and consistent profits.
d. low profits with occasional major losses.

c. low and consistent profits.

A run on a bank may occur if
a. depositors withdraw some funds to invest in the stock market.
b. required reserves are increased.
c. interest rates are raised.
d. depositors lose confidence in the bank and attempt to withdraw all their funds.
e. All of the above are correct.

d. depositors lose confidence in the bank and attempt to withdraw all their funds.

Bankers must always trade off
a. honesty and dishonesty.
b. stocks and loans.
c. prudence and profits.
d. gold and cash.
e. All of the above are correct.

c. prudence and profits.

It is imperative that banks maintain a reputation for safety in order that
a. regulators can reduce their efforts.
b. bank runs can be reduced or prevented.
c. customers will not be afraid to ask for loans.
d. stockholders can earn a high rate of return.

b. bank runs can be reduced or prevented.

Banking under a fractional reserve system is inherently risky, but
a. safe if banks are allowed to make profits.
b. regulation removes all danger of failures.
c. is always safely done with modern management.
d. is made safer with cautious and prudent management.

d. is made safer with cautious and prudent management.

In an economic system with privately owned, profit-maximizing banks, there will always be a difference between
a. private profits and social profits.
b. bank profits and other corporate profits.
c. bank profits and macroeconomic objectives.
d. bank profits and government profits.

c. bank profits and macroeconomic objectives.

One intention of deposit insurance is to reduce the danger of
a. excess lending.
b. excess profits.
c. risky lending.
d. bank runs.
e. All of the above are correct.

d. bank runs.

Bank regulation exists because public authorities are convinced that
a. the balance between public interest and safety does not affect profitability, and should be removed from the hands of managers.
b. the balance between bank profitability and public interest cannot be handled with legislation, but can be handled with regulation.
c. the balance between bank profitability and safety cannot be left to profit-maximizing managers.
d. the balance between bank safety and public interest can best be obtained by reliance on the market.

c. the balance between bank profitability and safety cannot be left to profit-maximizing managers.

Some bank regulation limits the types of assets that banks may own. The intent of this regulation is to
a. protect banks from competition.
b. provide banks with a minimum level of profits.
c. limit the level of bank profits.
d. maintain bank safety.
e. All of the above are correct.

d. maintain bank safety.

Banks are required to keep a minimum level of reserves on hand. The intent of this regulation is
a. monetary control rather than bank safety.
b. bank safety in case of bank runs.
c. maintenance of bank profits.
d. limiting the level of bank profits.

a. monetary control rather than bank safety.

The primary purpose of bank regulation is to
a. assure that banks do not get into financial trouble.
b. assure that banks lend to needy persons and businesses.
c. assure that banks maintain a minimum level of profits.
d. guarantee bank profitability and prevent stockholder losses.

a. assure that banks do not get into financial trouble.

Which of the following was true regarding sub-prime mortgages that were popular in 2005-2006?
a. More than 90% of these loans were made by regulated banks.
b. Bankers expected higher default rates on these loans.
c. They were generally fixed rate loans.
d. all of the above

b. Bankers expected higher default rates on these loans.

An asset of a bank is
a. the value of money that is on deposit.
b. the amount a depositor may legally borrow.
c. something of value that the bank owes to a depositor.
d. something of value that a bank owns.

d. something of value that a bank owns.

If a bank has $1,000,000 in reserves and checking deposits of $3,000,000, what is the bank's reserve position if the required reserve ratio is 20 percent?
a. The bank has $500,000 of required reserves and $500,000 of excess reserves.
b. The bank has $600,000 of required reserves and $400,000 of excess reserves.
c. The bank has $400,000 of required reserves and $600,000 of excess reserves.
d. The bank has $200,000 of required reserves and $800,000 of excess reserves.

b. The bank has $600,000 of required reserves and $400,000 of excess reserves.

The net worth of a bank is defined as the difference between
a. income and expenses.
b. assets and liabilities.
c. loans and deposits.
d. loans and reserves.

b. assets and liabilities.

When a banker accepts a deposit of $1,000 in cash and puts $200 aside as required reserves and then makes a loan of $800 to a new borrower, this set of transactions
a. decreases the money supply by $1,000.
b. decreases the money supply by $200.
c. does not change the money supply.
d. increases the money supply by $200.
e. increases the money supply by $800.

e. increases the money supply by $800.

Banks try to keep their level of excess reserves low because
a. the Fed charges a penalty for holdings of excess reserves.
b. they are concerned that the money multiplier will become too large.
c. they wish to maximize profits.
d. bank regulators levy fines on the amount of excess reserves.

c. they wish to maximize profits.

Excess reserves are put to use by a bank when it
a. puts cash in the vault to back existing loans.
b. pays off the mortgage on its building.
c. sells government securities.
d. makes loans to its customers.

d. makes loans to its customers.

If you have a checking account at a local bank, your bank account there is a(n)
a. asset to the bank and an asset to you.
b. liability of the bank and a liability of yours.
c. liability of the bank and an asset to you.
d. asset to the bank and a liability of yours.

c. liability of the bank and an asset to you.

The balance sheet of a solvent bank will show
a. assets \= liabilities - net worth.
b. assets \= liabilities + net worth.
c. net worth \= assets + liabilities.
d. liabilities \= assets + net worth.

b. assets \= liabilities + net worth.

The net worth of a bank is
a. equal to the value of assets.
b. equal to the value of deposits.
c. equal to the value of liabilities.
d. the value of assets less liabilities.
e. the value of loans and securities.

d. the value of assets less liabilities.

As of December 31, 2010, the assets listed on the balance sheet of Bank A were: $1.5 million in cash reserves, and $6 million in outstanding loans to its customers. Its liabilities totaled $6.5 million in checking deposits. What was the bank's net worth on that date?
a. $1 million
b. $4.5 million
c. $5 million.
d. $14 million.
e. Zero

a. $1 million

A liability to a bank is
a. something that the bank owns.
b. something that the bank owes.
c. something a customer owes the bank.
d. the value of bank buildings and hardware.

b. something that the bank owes.

One aspect of bank accounting is that many liabilities of banks are
a. assets of other persons and businesses in the economy.
b. also liabilities of other persons and businesses in the economy.
c. not matched by liabilities of most other banks.
d. not actually owed to any other person or business in the economy.

a. assets of other persons and businesses in the economy.

Do bankers create money?
a. No, they cannot do this as private businesses.
b. No, they are prevented by federal law.
c. Yes, through multiple deposit creation.
d. Yes, by opening checking accounts for customers.

c. Yes, through multiple deposit creation.

If Ms. Anniston transfers $1,000 from her checking account to her money market account, then
a. M1 falls and M2 remains the same.
b. M1 falls and M2 rises.
c. both M1 and M2 rise.
d. M1 remains the same and M2 rises.

a. M1 falls and M2 remains the same.

The oversimplified money multiplier formula, when the required reserve ratio is m, is
a. change in money supply \= change in reserves x m.
b. change in money supply \= (1/m) /change in reserves.
c. change in money supply \= (1/m) x change in reserves.
d. change in money supply \= m/change in reserves.

c. change in money supply \= (1/m) x change in reserves.

A single bank is limited in its ability to create money because
a. loan recipients usually take the proceeds of the loan in cash.
b. the FDIC will not permit it to create money unless the loans are guaranteed by the federal government.
c. the money loaned will probably be deposited in another bank.
d. federal legislation prohibits banks from creating money except to finance international trade.

c. the money loaned will probably be deposited in another bank.

The government banking regulation that places an upper limit on the money supply is
a. deposit insurance by the FDIC.
b. reserve requirements on bank deposits.
c. periodic bank examinations and audits.
d. limitations on the types of assets that a bank may own.

b. reserve requirements on bank deposits.

Which of the following is a drawback of FDIC insurance?
a. It leads to excess industry profits.
b. It has failed to arrest the trend of bank failures.
c. It leads to the problem of moral hazard.
d. It undercuts private insurance companies.

c. It leads to the problem of moral hazard.

Milly Miser removes $250,000 from her mattress and opens a checking account. This single transaction immediately increases the money supply by
a. $250,000.
b. $50,000.
c. $0.
d. -$250,000.

c. $0.

The required reserve ratio is 10 percent, but banks actually keep 20 percent on reserve. The actual money multiplier will be
a. 10.
b. 9.
c. 5.
d. 2.
e. 1.

c. 5.

The maximum increase in the money supply possible from a deposit of $D into the banking system where R is the reserve requirement is
a. (1/R)(D - R).
b. R x D.
c. (1/R)(1 - R)D.
d. (1/R)D.

c. (1/R)(1 - R)D.

The banking system receives a new cash deposit of $250,000. Total deposits eventually rise by $1 million. The value of the reserve ratio is
a. 25.
b. 4.
c. 0.50.
d. 0.25.
e. 0.20.

d. 0.25.

The money creation process generated by an injection of reserves stops when
a. people deposit their loans into other banks.
b. reserve requirements are raised.
c. the increase in required reserves equals the size of the injection.
d. bankers begin to fear runs and stop making loans.

c. the increase in required reserves equals the size of the injection.

An increase in the reserve ratio would tend to
a. increase excess reserves and raise the money multiplier.
b. decrease excess reserves and decrease the money multiplier.
c. increase excess reserves and decrease the money multiplier.
d. decrease excess reserves and raise the money multiplier.

b. decrease excess reserves and decrease the money multiplier.

The money creation formula is oversimplified because it assumes that
a. every recipient of a bank loan will redeposit the proceeds in another bank.
b. loan recipients will not take any of the proceeds in cash.
c. every bank lends out all excess reserves.
d. All of the above are correct.

d. All of the above are correct.

Which of the following might limit the money creation process to an amount less than the potential amount?
a. bank pursuit of profits
b. public holding some cash
c. business demand for loan
d. increased use of credit cards

b. public holding some cash

The deposit creation formula can be defined as
a. one minus the required reserve ratio.
b. the same as the GDP income multiplier.
c. the reciprocal of the required reserve ratio.
d. one plus the required reserve ratio.

c. the reciprocal of the required reserve ratio.

Systemic risks are most likely to exist with regard to
a. small governments.
b. large governments.
c. small financial institutions.
d. large financial institutions.

d. large financial institutions.

The money multiplier yielded by the deposit creation formula assumes that
a. banks hold no excess reserves.
b. banks hold excess reserves.
c. recipients of loans take some of the proceeds in cash.
d. recipients of loans do not redeposit their funds in other banks.

a. banks hold no excess reserves.