Chapter 21: Study Questions Key, Version A

Chapter 21: Study Questions Key, Version A Name: Class (day & time): Discussing the concepts and working examples with others is allowable. However, receiving answers from someone else, and turning these answers in as your own, is a form of academic dishonesty. Having someone else calculate your answers for you, and turning these answers in as your own, is likewise a form of academic dishonesty. As such, it is subject to the sanctions allowed by your university. Accordingly, the work and answers on this homework are mine and mine alone. I did not receive any assistance on this homework that constitutes academic dishonesty as such. Signed (your signature) Date 1. What part(s) of the U.S. government are primarily responsible for deciding fiscal policy actions? Congress & the President ( ½ pt for each) 2. What part(s) of the U.S. government are primarily responsible for deciding monetary policy actions? The Federal Reserve (U.S. Federal Reserve, etc.) ( ½ pt if only The Fed ) 3.. C. Assume the government has $10 Trillion of debt in 2013. If $2 Trillion of this debt is monetized, this means: a. there is a $2 trillion tax increase that is earmarked to retire this debt. b. the government refuses to re-pay this debt. It is a default on $2 trillion of U.S. government debt. c. $2 Trillion of new currency is printed to effectively retire the debt. d. Government spending is cut by $2 trillion. The taxes that would have gone to this savings are, instead, used to retire this debt. 4.. B. Assume the government has $10 Trillion of debt in 2013. If $2 Trillion of this debt is monetized, this means: a. The Federal Reserve sells $2 Trillion of U.S. government bonds. b. The Federal Reserve buys $2 Trillion of U.S. government bonds. c. The Federal Reserve lowers the official exchange rate at which the dollar trades for. The Federal reserve makes the dollar depreciate relative to foreign currencies. d. The Federal Reserve increases the official exchange rate at which the dollar trades for. The Federal Reserve makes the dollar appreciate relative to foreign currencies. 5.. B. According to the text, an economy that relies solely on barter when trading will: a. have a less equal income distribution than modern economies. b. have difficulty achieving high levels of specialization and production. c. have lower interest rates than a modern economy. d. be more stable (fewer recession) than a modern economy. 1

6.. C. Which of the following best illustrates a double coincidence of wants, as defined by the text? a. Both Henry and Richard want the same thing, to be King. b. Lady MacBeth is torn. She wants to both: 1) keep her crimes a secret and, 2) confess her crimes. c. Romeo wants to date Juliet. Juliet wants to date Romeo. 7.. A. Which of the following best define a highly liquid asset? a. an asset that can rapidly and easily be spent for its normal value b. an asset with a very high long-run rate of return c. a financial asset that can also be used as a commodity d. a class of assets, cars for example, that is sold all over the world Part of Part of M1? M2? 8.. $2,100 B. Given the information at right, what is the value of M1? Currency in circulation + Checking Accounts = M1 Money supply 9.. $6,800 B. Given the information at right, what is the value of M2? (Not on final) 2 Item Amount Yes Money Market Mutual Funds $ 800 billion Yes Savings Accounts $ 3,100 billion Yes Yes Currency in Circulation $ 600 billion Yes Small Time Deposits (CDs < $100,000) $ 800 billion Currency in bank vault or at Fed $ 200 billion Commercial Paper $ 300 billion Yes Yes Checking Accounts $ 1,500 billion Govt. Bonds held by the Fed $ 1,800 billion 10-12. What was the basis or backing for the U.S. dollar during each time period? Use 1 check per row. Time period Gold Silver Silver & Gold Fiat Money 10. 1792-1860 11. 1900-1932 12. 1972 - Today British Currency Spanish Currency Stay-Puff Marshmellows 13.. C. Which of the following is true of fractional reserve banking? a. Fractional reserve banking was legal for most of the 1800 s but is not legal today. b. Fractional reserve banking was illegal for most of the 1800 s but is legal today. c. Fractional reserve banking helps banks make profits. It also leads to more physical investment for the economy. d. Fractional reserve banking helps banks make profits. It, however, leads to less physical investment for the economy. 14.. B. Bank Banque has just opened. New customers (i.e. depositors) put $25 billion of their cash into Bank Banque. Bank Banque gives these depositors checking accounts? What does Bank Banque do with the $25 billion it received? Bank Banque: a. Keeps almost all of the $25 as cash, but issues about $25 billion in new savings accounts to borrowers using the $25 billion as collateral. b. keeps some (about $3 billion) of the $25 billion in cash, but lends most of it ( $22 billion) out. c. deposits almost all of the $25 billion at the Federal Reserve. In return Bank Banque gets private commercial paper it can lend to customers. d. deposits almost all of the $25 billion at the Federal Reserve. In return Bank Banque gets Federal Reserve Special Drawing rights it can lend to customers.

15.. A. In the long-run, how do the bank s actions in # 14 affect society? a. Savings is channeled into new physical capital. The economy grows faster as a result. b. High savings is rewarded. This means less consumption & an economy that grows more slowly. c. The money supply decreases. While this can push an economy into recession in the short-run, in the long-run, the economy grows at a normal pace but has lower inflation. d. The money supply decreases. While this can stimulate an economy in the short-run, in the longrun, the economy grows more slowly in the long-run. # 16 17: Hank s Bank has the following levels of cash and customer accounts: Total cash held by Hank s Bank: $ 26 billion Checking accounts at Hank s Bank: $200 billion Other depositors accounts at Hank s Bank (savings, etc): $0 (none) 16. If the required reserve ratio is 0.12, what are Hank s Bank s required reserves?. 0.12 $200 B = $24 B. Don t forget the units (ex. $ s and billions) and a - if it s a negative #. 17. If the required reserve ratio is 0.12, what are Hank s Bank s excess reserves?. $26 B - $24 B = $2 B. Don t forget the units (ex. $ s and billions) and a - if it s a negative #. 18.. A. When a bank loans cash, the bank: a. gives away a liquid asset (the cash) in exchange for a less liquid asset (the IOU or loan). b. gives away a illiquid asset (the cash) in exchange for a highly liquid asset (the IOU or loan). c. prints its own money as allowed by the U.S. Federal Reserve d. draws from its allotted reserve of money the Federal Reserve printed for that bank 19.. C. When a bank loans cash, the bank: a. creates new wealth for itself but destroys wealth for the borrower b. decreases its wealth for itself but creates new wealth for the borrower c. gives away an asset that doesn t earn the bank any money (the cash) in exchange for an asset that does earn the bank money (the IOU or loan). d. decreases the wealth of the government (the source of the newly printed cash) but creates new wealth for the borrower 20.. D. The more of its cash that a bank loans: a. the more newly printed money that bank is legally entitled to. b. the lower its taxable assets are, resulting in lower taxes for the bank. c. the less money it can earn (assuming the loans are good loans). d. the more money it can earn (assuming the loans are good loans). 21.. A. As a bank lends out more and more its cash, it becomes: a. less able to meet a run on the bank. b. more able to meet a run on the bank. 3

# 22 23: The economy is currently at point 1 as indicated at right. You are the Chair of the U.S. Federal Reserve and want to use monetary policy to return the economy back to natural GDP. PPC 22.. A. What should you do? a. Attempt to increase the money supply b. attempt to decrease the money supply c. offer to take high interest, short-term government bonds from the private sector and give them low-interest, but long-term, government bonds in exchange d. offer to take low interest, short-term government bonds from the private sector and give them high-interest, but long-term, government bonds in exchange e. None of the above are appropriate monetary policy. Good X 23.. D. What else should you do? a. Lower the $ s official exchange rate for international transactions. i.e. Declare the $ buys fewer units of foreign currency. b. Increase the $ s official exchange rate for international transactions. i.e. Declare the $ buys more units of foreign currency. c. Increase the discount rate. d. Lower the discount rate. e. None of the above are appropriate monetary policy. # 24 25: Yikes! It s 2020 and a wave of panic has gripped the United States. Millions of customers are lining up at banks to withdraw their cash. 24.. B. What can banks do to alleviate this crises? a. Print Certificates of Deposit instead of giving their depositors cash. The bank promises to accept each $1.00 of CD s as payment, &, at a specified time in the future, give $1 cash for each $1 of CD s. b. Borrow from the U.S. Federal Reserve (assuming it acts as a lender of last resort). c. Offer their depositors an increase in their checking account if the depositor agrees to not withdraw any cash for a certain period of time. d. All of the above are legal and common methods to deal with banking panics. 25.. A. What does the U.S. government do to help ensure that such a bank panic does not occur in the first place? a. Regularly collect money from banks and use it as insurance to guarantee depositors will get their money even if a bank fails. b. Regularly declare banking holidays, short periods of time in which customers can still write check (and use their debit cards), but cannot withdraw cash from banks. c. Allow banks to issue different classes of checking accounts. Some offer high interest but the depositor cannot withdraw cash on short notice. Others pay low (or no) interest but allow depositors to withdraw cash from the bank at any time. Good Y 4

26. _C_ What is one way the U.S. Federal Reserve attempts to regulate the U.S. banking system? a. The Federal Reserve directly sets the interest rate at which banks lend for each category of loans. For example, the Federal Reserve sets the rate for all classes (based on risk, etc) of home loans. b. While the exchange rate (ex. $ s per Euro) for private transactions is set by markets, the exchange rate for all government transactions is set by the Fed. c. The Federal Reserve sets the required reserve ratio. d. All of the above are correct. # s 27 30: Assume the economy is at point 1 on the PPC diagram at right. The Fed wishes to use monetary policy to return the economy to Natural GDP. PPC 27. _C_ What is the most appropriate goal of the Fed? a. increase the money supply & increase interest rates b. increase the money supply & decrease interest rates c. decrease the money supply & increase interest rates d. decrease the money supply & decrease interest rates Good Y 28. _A_ What should the Fed do with the Discount Rate? a. increase the discount rate b. decrease the discount rate c. leave the discount rate unchanged Good X 29. _B_ What should the Fed do regarding its lending policies? a. increase the amount it is willing to lend to U.S. banks b. decrease the amount it is willing to lend to U.S. banks c. leave the amount it is willing to lend to U.S. banks unchanged d. increase its lending to foreign banks, but decrease its lending to U.S. banks 30. _A_ Which of the following policies should the Fed pursue? a. sell government bonds to the private sector b. renegotiate with current holders of U.S. government bonds to make the bonds due later than originally specified, but in return, have the bonds pay higher interest c. renegotiate with current holders of U.S. government bonds to make the bonds due sooner than originally specified, but in return, have the bonds pay lower interest d. buy government bonds from the private sector # s 31 34: Assume the economy is at point 1 on the AD-SRAS diagram at right. The Fed wishes to use monetary policy to return the economy to Natural GDP. Price Level Goods & Services Markets SRAS 31. _B_ What is the most appropriate goal of the Fed? a. increase the money supply & increase interest rates b. increase the money supply & decrease interest rates c. decrease the money supply & increase interest rates d. decrease the money supply & decrease interest rates P 1 LRAS AD 5 1 Q (Real GDP)

32. _B_ What should the Fed do with the Discount Rate? a. increase the discount rate b. decrease the discount rate c. leave the discount rate unchanged 33. _A_ What should the Fed do regarding its lending policies? a. increase the amount it is willing to lend to U.S. banks b. decrease the amount it is willing to lend to U.S. banks c. leave the amount it is willing to lend to U.S. banks unchanged d. increase its lending to foreign banks, but decrease its lending to U.S. banks 34. _D_ Which of the following policies should the Fed pursue? a. sell government bonds to the private sector b. renegotiate with current holders of U.S. government bonds to make the bonds due later than originally specified, but in return, have the bonds pay higher interest c. renegotiate with current holders of U.S. government bonds to make the bonds due sooner than originally specified, but in return, have the bonds pay lower interest d. buy government bonds from the private sector 35. _C_ Which of the following best describe a liquidity trap? a. People spend almost all their money rather than saving it. The high spending causes the economy to boom, but banks lack money to lend thereby hindering long-run growth. b. The Federal Reserve creates too much money and the financial system decides it has too much liquidity. Banks slash interest rates, greatly increase lending, and cause an inflationary bubble. c. Banks have money to lend, but won t lend it. They are too worried about potential bank runs & loans defaulting. d. The Federal Reserve creates too much money. People decide that the $, while good for purchases today, is a bad way to save for the future. Spending increases and causes an inflationary bubble. 36. _B_ Is there any evidence the U.S. experienced a liquidity trap in modern times (ex. the last 100 years)? a. Yes, but only during the U.S. Great Depression. b. Yes, during both the U.S. Great Depression and the recent (2008-2011) U.S. downturn. c. No, but evidence indicates Germany did during the 1920 s. d. No, but Germany did in the 1920 s & many Latin American countries did during the 1980 s & 90 s. 37. _D_ What, if any, are the consequences of a liquidity trap? a. In the short-run the economy booms, but in the long-run it is left with high & persistent inflation. b. A nation s currency will greatly fall in value relative to other currencies. c. A nation s currency will greatly increase in value relative to other currencies. d. Monetary stimulus will not, in the short-term, give the economy much stimulus. 6

_A_ Yikes! There is panic, great panic, in the street & especially in the U.S. financial system. People are lining up to get their cash out their banks. What problem will banks likely run into? a. Banks need to borrow cash to pay their depositors. However, since all (or at least most) banks also want to borrow cash, banks have nowhere in the private sector from which to borrow. b. Depositors will want to buy gold (and silver) backed securities. Cash will pour into banks, but banks will run short of gold (and silver) backed securities. c. Debtors will want to get rid of cash to reduce their debt load. Instead of paying off their bank loans early, debtors will dump massive amounts of cash into mutual funds. Banks will have to borrow from mutual funds at high interest rates to get their cash. 38. _A_ What can banks do to alleviate the problem in # 38? a. Borrow from the U.S. Federal Reserve (assuming it acts as a lender of last resort). b. Offer their depositors an increase in their checking account if the depositor agrees to not withdraw any cash for a certain period of time. c. Print Certificates of Deposit instead of giving their depositors cash. The bank promises to accept each $1.00 of CD s as payment, &, at a specified time in the future, give $1 cash for each $1 of CD s. d. All of the above are legal and common methods to deal with banking panics. 7