Critical Thinking Questions

19 . How do banks create money? 20 . What is the formula for the money multiplier? 21 . What is the difference between an environment of limited reserves and ample reserves?

Critical Thinking Questions

22 . The Bring it Home Feature discusses the use of cowrie shells as money. Although we no longer use cowrie shells as money, do you think other forms of commodity monies are possible? What role might technology play in our definition of money? 23 . Imagine that you are a barber in a world without money. Explain why it would be tricky to obtain groceries, clothing, and a place to live. 24 . Explain why you think the Federal Reserve Bank tracks M1 and M2. 25 . The total amount of U.S. currency in circulation divided by the U.S. population comes out to about $3,500 per person. That is more than most of us carry. Where is all the cash? 26 . Explain the difference between how you would characterize bank deposits and loans as assets and liabilities on your own personal balance sheet and how a bank would characterize deposits and loans as assets and liabilities on its balance sheet. 27 . Should banks have to hold 100% of their deposits? Why or why not? 28 . Explain what will happen to the money multiplier process if there is an increase in the reserve requirement? 29 . What do you think the Federal Reserve Bank did to the reserve requirement during the 2008–2009 Great Recession?

Problems

30 . If you take $100 out of your piggy bank and deposit it in your checking account, how did M1 change? Did M2 change? 31 . A bank has deposits of $400. It holds reserves of $50. It has purchased government bonds worth $70. It has made loans of $500. Set up a T-account balance sheet for the bank, with assets and liabilities, and calculate the bank’s net worth. 32 . Humongous Bank is the only bank in the economy. The people in this economy have $20 million in money, and they deposit all their money in Humongous Bank. a. Humongous Bank decides on a policy of holding 100% reserves. Draw a T-account for the bank. b. Humongous Bank is required to hold 5% of its existing $20 million as reserves, and to loan out the rest. Draw a T-account for the bank after it has made its first round of loans. c. Assume that Humongous bank is part of a multibank system. How much will money supply increase with that original $19 million loan?