Banks and Money Creation

Problem Set
1. Which of the following is considered to be money? C. makes the money supply equal to the amount of currency
A. Google stock in circulation.
B. Bonds D. results in the money supply being less than the amount
C. Credit cards of currency in circulation.
D. Checking account deposits E. creates an economic system that is inferior to the barter
E. Real estate economy.

2. Buying the latest compact disc with a $20 bill means 9. Suppose the banking system does NOT hold excess
money is functioning as a: reserves and the reserve ratio is 25%. If Melanie deposits
A. medium of exchange. $1,000 of cash into her checking account, the banking
B. store of value. system can increase the money supply by:
C. unit of account. A. $5,000.
D. standard of deferred payment. B. $1,000.
E. form of near money. C. $3,000.
D. $4.000.
3. If you transfer $1,000 from your savings account to your E. $1,250.
checking account:
A. M1 decreases by $1,000, and M2 increases by $1,000. 10. If a bank has deposits of $100,000, loans of $75,000, cash
B. M1 increases by $1,000, and M2 decreases by $1,000. on hand of $10,000, and $15,000 on deposit at the Federal
C. M1 and M2 don't change. Reserve, then its reserve ratio is:
D. M1 increases by $1,000, but M2 doesn't change. A. 5%.
E. M2 decreases by $1,000, but M1 doesn’t change. B. 10%.
C. 12.5%.
4. The reserve ratio is the: D. 25%.
A. bank's holdings of gold. E. 75%.
B. government's holdings of gold at Fort Knox.
C. fraction of deposits the banks hold in their vaults. 11. Suppose the reserve ratio is 20%. If Sam deposits $500 into
D. ratio of gold to the paper money in the economy. his checking account, his bank can increase loans by:
E. fraction of deposits that are lent to borrowers. A. $500.
B. $2,500.
Use the t-account below to answer questions 5-6. C. $100.
D. $400.
Assets Liabilities E. $300.
Reserves = $20,000 Deposits = _________
Loans = _______ 12. Suppose a bank already has excess reserves of $800 and
the reserve ratio is 20%. If Andy deposits $1,000 of cash
5. If the reserve ratio is 25%, deposits are: into his checking account and the bank lends $600 to
A. $5,000. Melanie, that bank can lend an additional:
B. $15,000. A. $200.
C. $60,000. B. $1,000.
D. $80,000. C. $800.
E. $100,000. D. $2,400.
E. $400.
6. If the reserve ratio is 25%, loans are:
A. $5,000. 13. Suppose your grandma sends you $100 for your birthday
B. $15,000. and you deposit $100 into your checking account at the local
C. $60,000. bank. The reserve ratio is 10%. Based upon this deposit, the
D. $80,000. bank's excess reserves have increased by _____ and, if the
E. $20,000. bank lends all excess reserves, the money supply could
eventually grow by as much as _____.
7. First National Bank has $80 million in checkable deposits, $15 A. $90; $1000
million in deposits with the Federal Reserve, $5 million cash in B. $100; $900
the bank vault and $5 million in government bonds. Given this C. $90; $900
information the First National Bank has liabilities of: D. $100; $1000
A. $105 million. E. $1000; $10,000
B. $95 million. Use the information in the box below to answer questions 14-15 .
C. $85 million.
D. $100 million. The reserve requirement is 20%, and Leroy deposits his
E. $80 million. $1,000 check received as a graduation gift in his checking
8. The existence of banks: account. The bank does NOT want to hold excess reserves.
A. results in the money supply being larger than the
amount of currency in circulation.
B. inhibits the creation of money. 14. How much can the bank loan based on the $1,000
deposit?
 A. $1,000 C. $4,000
B. $200 D. $5,000
C. $800 E. $10,000
D. $0
E. $900

15. What is the maximum expansion in the money supply

possible?
A. $1,000
B. $1,800

16. The government of Eastlandia uses measures of monetary Item Amount

aggregates similar to those used by the United States, and Bank deposits at the central bank $200 million
the central bank of Eastlandia imposes a required reserve Currency held by public $150 million
ratio of 10%. Use the information in the table to the right to Currency in bank vaults $100 million
answer the following questions: Checkable bank deposits $500 million
a. What is M1? Traveler’s checks $10 million
M1 equals the sum of currency held by the public ($150 million, checkable deposits ($500 million), and
traveler’s checks ($10 million), or $660 million.
b. Are the commercial banks holding excess reserves?
Required reserves are $50 million (10% of $500 million). Because total reserves are $300 million [currency in
bank vaults ($100 million) + bank deposits at the central bank ($200 million)], the commercial banks are
holding $250 million ($300 million - $50 million) in excess reserves.

17. Assume that $1,000 is deposited in the bank, and that each bank loans out all of its excess reserves. For each of the
following required reserve ratios, calculate the amount that the bank must hold in required reserves, the amount that
will be excess reserves, the deposit expansion multiplier and the maximum amount that the money supply could
increase.
Required Reserve Ratio
1% 5% 10% 15% 25%

Required reserves $10 $50 $100 $150 $250

Excess reserves $990 $950 $900 $850 $750

Money multiplier 100 20 10 6.67 4

Maximum increase in M1 $99,000 $19,000 $9,000 $5,669.50 $3,000

18. Suppose that the T-account for First National Bank is

First National Bank T-Account
as follows: Assets Liabilities
a. If the Fed requires banks to hold 5 percent of Reserves $100,000 Deposits $500,000
deposits as reserves, how much in excess
reserves does First National now hold? Loans $400,000
If the required reserve ratio is 5%, then First
National Bank’s required reserves are
 $500,000 X 0.5 = $25,000. Because the bank’s total reserves are $100,000, it has excess reserves of
$75,000.
b. Assume that all other banks hold only the required amount of reserves. If First national decides to reduce its
reserves to only the required amount, by how much would the economy’s money supply increase?
With a required reserve ratio of 5%, the money multiplier is 1/0.05 = 20. If First National Bank lends out
its excess reserves of $75,000, the money supply will eventually increase by $75,000 X 20 - $1,500,000

19. If the Federal Reserve wants to increase the money supply, should it raise or lower the reserve requirement? Why?
The Federal Reserve should lower the required reserve ratio. Banks would have more excess reserves to lend
out and, thus, the money supply could increase.