STUDY GUIDE for Chapter 14

How Banks Create Money



         1.    The reserves of a commercial bank consist of:

                A)   the amount of money market funds it holds.

                B)    deposits at the Federal Reserve Bank and vault cash.

                C)    government securities that the bank holds.

                D)   the bank's net worth.



         2.    The goldsmith's ability to create money was based on the fact that:

                A)   withdrawals of gold tended to exceed deposits of gold in any given time period.

                B)    consumers and merchants preferred to use gold for transactions, rather than paper money.

                C)    the goldsmith was required to keep 100 percent gold reserves.

                D)   paper money in the form of gold receipts was rarely redeemed for gold.



         3.    The primary purpose of the legal reserve requirement is to:

                A)   prevent banks from hoarding too much vault cash.

                B)    provide a means by which the monetary authorities can influence the lending ability of commercial banks.

                C)    prevent commercial banks from earning excess profits.

                D)   provide a dependable source of interest income for commercial banks.



         4.    Banks create money when they:

                A)   add to their reserves in the Federal Reserve Bank.

                B)    accept deposits of cash.

                C)    sell government bonds.

                D)   exchange checkable deposits for the IOU's of businesses and individuals.



         5.    Assume that a bank initially has no excess reserves.  If it receives $5,000 in cash from a depositor and the bank finds that it can safely lend out $4,500, the reserve requirement must be:

                A)   zero.

                B)    10 percent.

                C)    20 percent.

                D)   25 percent



         6.    In prosperous times banks are likely to hold very small amounts of excess reserves because:

                A)   the Fed wants commercial banks to increase the money supply during economic expansions.

                B)    it is very costly to transfer funds between commercial banks and the central banks.

                C)    the Federal Reserve Banks do not pay interest on bank reserves.

                D)   the Federal Reserve Banks want to minimize their interest payments on such deposits.



         7.    If a portion of the loans extended by commercial banks is taken as cash rather than as checkable deposits, the maximum money-creating potential of the commercial banking system will:

                A)   be equal to twice the reciprocal of the reserve ratio.

                B)    be unaffected.

                C)    increase.

                D)   decrease.



         8.    A bank temporarily short of required reserves may be able to remedy this situation by:

                A)   borrowing funds in the Federal funds market.

                B)    granting new loans.

                C)    shifting some of its vault cash to its reserve account at the Federal Reserve.

                D)   buying bonds from the public.



         9.    Other things equal, if the required reserve ratio was lowered:

                A)   banks would have to reduce their lending.

                B)    the size of the monetary multiplier would increase.

                C)    the actual reserves of banks would increase.

                D)   the Federal funds interest rate would rise.



       10.    (Last Word) A "national bank holiday" that closed all banks for a week and resulted in Federal deposit insurance occurred in the United States in:

                A)   1903, following the "Louisiana stampede."

                B)    1987, following the collapse of numerous savings and loan associations.

                C)    1945, following the end of the Second World War.

                D)   1933, following the bank panics of 1930-1933.




Answer Key -- SG14


         1.    B            

         2.    D            

         3.    B            

         4.    D            

         5.    B            

         6.    C            

         7.    D            

         8.    A            

         9.    B            

       10.    D