1. What is commodity money? What is fiat money? Which kind do we use?
2. What are demand deposits, and why should they be included in the stock of
money?
3. Who is responsible for setting monetary policy in the United States? How is this
group chosen?
4. If the Fed wants to increase the money supply with open-market operations, what
does it do? Buy bonds
5. Why don’t banks hold 100 percent reserves? How is the amount of reserves banks
hold related to the amount of money the banking system creates?
6. What is the discount rate? What happens to the money supply when the Fed
raises the discount rate? Decrease
7. What are reserve requirements? What happens to the money supply when the
Fed raises reserve requirements? Decrease
8. Why can’t the Fed control the money supply perfectly?
9. Which of the following are money in the U.S. economy?
Which are not? Explain your answers by discussing each of the three functions
of money.
a. a U.S. penny
b. a Mexican peso
c. a Picasso painting
d. a plastic credit card
10. Your uncle repays a $100 loan from Tenth National Bank by writing a $100
check from his TNB checking account. Use T-accounts to show the effect of this
transaction on your uncle and on TNB. Has your uncle’s wealth changed? Explain.
11. The Federal Reserve conducts a $10 million open-market purchase of
government bonds. If the required reserve ratio is 10 percent, what is the largest
possible increase in the money supply that could result? Explain. What is the
smallest possible increase? Explain.
13. Assume that the banking system has total reserves of $100 billion. Assume also
that required reserves are 10 percent of checking deposits, and that banks hold no
excess reserves and households hold no currency.
a. What is the money multiplier? What is the money supply?
b. If the Fed now raises required reserves to 20 percent of deposits, what is
the change in reserves and the change in the money supply?
14. Assume that the reserve requirement is 20%. Also assume that banks do not
hold excess reserves and there is no cash held by public. The Federal Reserve
decides that it wants to expand the money supply by $40 million dollars.
a. If the Fed is using open-market operations, will it buy or sell bonds?
b. What quantity of bonds does the Fed need to buy or sell to accomplish the
goal? Explain your reasoning.
15. Suppose banks install automatic teller machines on every block and, by
making cash readily available, reduce the amount of money people want to hold.
a. Assume the Fed does not change the money supply. According to the
theory of liquidity preference, what happens to the interest rate? What
happens to aggregate demand?
b. If the Fed wants to stabilize aggregate demand, how should it
respond?
16. Explain how each of the following developments would affect the supply of
money, the demand for money, and the interest rate. Illustrate your answers with
diagrams.
a. The Fed’s bond traders buy bonds in open-market operations.
b. An increase in credit card availability reduces the cash people hold.
c. The Federal Reserve reduces banks’ reserve requirements.
d. Households decide to hold more money to use for holiday shopping.
e. A wave of optimism boosts business investment and expands aggregate
demand.
17. The Federal Reserve expands the money supply by 5 percent.
a. Use the theory of liquidity preference to illustrate in a graph the impact of
this policy on the interest rate.
b. Use the model of aggregate demand and aggregate supply to illustrate the
impact of this change in the interest rate on output and the price level in the
short-run.
c. When the economy makes the transition from its short-run equilibrium to its
long-run equilibrium, what will happen to the price level?
d. How will this change in the price level affect the demand for money and the
equilibrium interest rate?
e. Is this analysis consistent with the proposition that money has real effects in
the short-run but is neutral in the long-run?
18. The economy is in a recession with high unemployment and low output.
a. Identify an open-market operation that would restore the economy to its
natural level.
b. Draw a graph of the money market to illustrate the effect of this open-
market operation. Show the resulting change in the interest rate.
