Review Questions

network of banks making loans, people making deposits, and banks making more loans creates much of the money in an economy. Given the macroeconomic dangers of a malfunctioning banking system, Monetary Policy and Bank Regulation will discuss government policies for controlling the money supply and for keeping the banking system safe.

1. In many casinos, a person buys chips to use for gambling. Within the casino's walls, customers often can use these chips to buy food and drink or even a hotel room. Do chips in a gambling casino serve all three functions of money? 2. Can you name some item that is a store of value, but does not serve the other functions of money? 3. If you are out shopping for clothes and books, what is easiest and most convenient for you to spend: M1 or M2? Explain your answer. 4. For the following list of items, indicate if they are in M1, M2, or neither: a. Your $5,000 line of credit on your Bank of America card b. $50 dollars’ worth of traveler’s checks you have not used yet c. $1 in quarters in your pocket d. $1200 in your checking account e. $2000 you have in a money market account 5. Explain why the money listed under assets on a bank balance sheet may not actually be in the bank? 6. Imagine that you are in the position of buying loans in the secondary market (that is, buying the right to collect the payments on loans) for a bank or other financial services company. Explain why you would be willing to pay more or less for a given loan if: a. The borrower has been late on a number of loan payments b. Interest rates in the economy as a whole have risen since the bank made the loan c. The borrower is a firm that has just declared a high level of profits d. Interest rates in the economy as a whole have fallen since the bank made the loan

7. What are the four functions that money serves? 8. How does the existence of money simplify the process of buying and selling? 9. What is the double-coincidence of wants? 10. What components of money do we count as part of M1? 11. What components of money do we count in M2? 12. Why do we call a bank a financial intermediary? 13. What does a balance sheet show? 14. What are a bank's assets? What are its liabilities? 15. How do you calculate a bank's net worth? 16. How can a bank end up with negative net worth? 17. What is the asset-liability time mismatch that all banks face? 18. What is the risk if a bank does not diversify its loans? 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?

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?

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?