Chapter 14

Chapter 14
Determinants of the Money Supply
14.1 The Money Supply Model and the Money Multiplier
1) Models describing the determination of the money supply and the Fedʹs role in this process
normally focus on ________ rather than ________, since Fed actions have a more predictable
effect on the former.
A) reserves; the monetary base
B) reserves; high-powered money
C) the monetary base; high-powered money
D) the monetary base; reserves
Answer: D
Ques Status: Previous Edition
2) The Fed can exert more precise control over ________ than it can over ________.
A) high-powered money; reserves
B) high-powered money; the monetary base
C) the monetary base; high-powered money
D) reserves; high-powered money
Answer: A
3) The ratio that relates the change in the money supply to a given change in the monetary base
is called the
A) money multiplier.
B) required reserve ratio.
C) deposit ratio.
D) discount rate.
Answer: A
Chapter 14 Determinants of the Money Supply 351
4) The formula linking the money supply to the monetary base is

A) M = m/MB.
B) M = m × MB.
C) m = M × MB.
D) MB = M × m.
E) M = m + MB.
Answer: B
5) The variable that reflects the effect on the money supply of changes in factors other than the
monetary base is the
A) currency-checkable deposits ratio.
B) required reserve ratio.
C) money multiplier.
D) nonborrowed base.
Answer: C
6) An assumption in the model of the money supply process is that the desired levels of currency
and excess reserves
A) are given as constants.
B) grow proportionally with checkable deposits.
C) grow proportionally with high-powered money.
D) grow proportionally over time.
Answer: B
Ques Status: New
7) The total amount of reserves in the banking system is equal to the ________ required reserves
and excess reserves.
A) sum of
B) difference between
C) product of
D) ratio between
Answer: A
Ques Status: New
352 Mishkin · Economics of Money, Banking, and Financial Markets, Eighth Edition
8) The total amount of required reserves in the banking system is equal to the ________ the
required reserve ratio and checkable deposits.
A) sum of
B) difference between
C) product of
D) ratio between
Answer: C
Ques Status: New
9) Since the Federal Reserve sets the required reserve ratio to less than one, one dollar of reserves
can support ________ of checkable deposits.
A) exactly one dollar
B) less than one dollar
C) more than one dollar
D) exactly twice the amount
Answer: C
Ques Status: New
10) The equation that shows the amount of the monetary base needed to support existing levels of
checkable deposits, excess reserves, and currency is
A) MB = (r × D) + ER + C.
B) MB = (r + D) + ER + C.
r
C) MB = + ER + C.
D
D) MB = (r × D) - ER - C.
Answer: A
Ques Status: Revised
11) An increase in the monetary base that goes into ________ is not multiplied, while an increase
that goes into ________ is multiplied.
A) deposits; currency
B) excess reserves; currency
C) currency; excess reserves
D) currency; deposits
Answer: D
12) An increase in the monetary base that goes into currency is ________, while an increase that
goes into deposits is ________.
A) multiplied; multiplied
B) not multiplied; multiplied
C) multiplied; not multiplied
D) not multiplied; not multiplied
Answer: B
13) If the Fed injects reserves into the banking system and they are held as excess reserves, then
the money supply
A) increases by only the initial increase in reserves.
B) increases by only one-half the initial increase in reserves.
C) increases by a multiple of the initial increase in reserves.
D) does not change.
Answer: D
14) If the Fed injects reserves into the banking system and they are held as excess reserves, then
the monetary base ________ and the money supply ________.
A) remains unchanged; remains unchanged
B) remains unchanged; increases
C) increases; increases
D) increases; remains unchanged
Answer: D
15) The formula that links checkable deposits to the monetary base is
1
A) m = .
r+e+c
1
B) M = .
r+ e+ c
1+c
C) M = .
r+ e+ c
1
D) D = .
r+e+c
1
E) D = × MB.
r+e+c
Answer: E
16) The formula that links checkable deposits to the money supply is
1+c
A) M = .
D
1
B) M = × D.
1+c
1
C) D = × M.
1+c
D) D = (1 + c) × M
Answer: C
Ques Status: New
17) The formula for the M1 money multiplier is

A) m = (1 + c)/(r + e + c).
B) M = 1/(r + e + c).
C) M = (1 + c)/(r + e + c).
D) m = [1/(r + e + c)] × MB.
Answer: A
18) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable
deposits are $800 billion, and excess reserves total $0.8 billion, then the money supply is
A) $8000.
B) $1200.
C) $1200.8.
D) $8400.
Answer: B
deposits are $800 billion, and excess reserves total $0.8 billion, then the M1 money multiplier is
A) 2.5.
B) 1.67.
C) 2.0.
D) 0.601.
Answer: A
deposits are $800 billion, and excess reserves total $0.8 billion, then the currency ratio is
A) 0.25.
B) 0.50.
C) 0.40.
D) 0.05.
Answer: B
deposits are $800 billion, and excess reserves total $0.8 billion, then the excess
reserves-checkable deposit ratio is
A) 0.001.
B) 0.10.
C) 0.01.
D) 0.05.
Answer: A
deposits are $800 billion, and excess reserves total $0.8 billion, then the monetary base is
A) $480 billion.
B) $480.8 billion.
C) $80 billion.
D) $80.8 billion.
Answer: B
A) 2.5.
B) 1.67.
C) 2.3.
D) 0.651.
Answer: C
A) 2.5.
B) 2.72.
C) 2.3.
D) 0.551.
Answer: B
deposits are $1000 billion, and excess reserves total $1 billion, then the money supply is
A) $10,000.
B) $4000.
C) $1400.
D) $10,400.
Answer: C
deposits are $1000 billion, and excess reserves total $1 billion, then the M1 money multiplier is
A) 2.5.
B) 2.8.
C) 2.0.
D) 0.7.
Answer: B
deposits are $1000 billion, and excess reserves total $1 billion, then the currency ratio is
A) 0.25.
B) 0.50.
C) 0.40.
D) 0.05.
Answer: C
deposits are $1000 billion, and excess reserves total $1 billion, then the excess
reserves-checkable deposit ratio is
A) 0.01.
B) 0.10.
C) 0.001.
D) 0.05.
Answer: C
deposits are $1000 billion, and excess reserves total $1 billion, then the monetary base is
A) $400 billion.
B) $401 billion.
C) $500 billion.
D) $501 billion.
Answer: D
deposits are $1000 billion, and excess reserves total $1 billion, then the M1 money multiplier is
A) 2.54.
B) 2.67.
C) 2.35.
D) 0.551.
Answer: A
31) If the required reserve ratio is one-third, currency in circulation is $300 billion, and checkable
deposits are $900 billion, then the money supply is
A) $2700.
B) $3000.
C) $1200.
D) $1800.
Answer: C
deposits are $900 billion, then the M1 money multiplier is
A) 2.5.
B) 2.8.
C) 2.0.
D) 0.67.
Answer: C
deposits are $900 billion, then the currency ratio is
A) 0.25.
B) 0.33.
C) 0.67.
D) 0.375.
Answer: B
deposits are $900 billion, then the level of excess reserves in the banking system is
A) $300 billion.
B) $30 billion.
C) $3 billion.
D) 0.
Answer: D
deposits are $900 billion, then the monetary base is
A) $300 billion.
B) $600 billion.
C) $333 billion.
D) $667 billion.
Answer: B
14.2 Factors That Determine the Money Multiplier
1) Everything else held constant, an increase in the required reserve ratio on checkable deposits
will cause
A) the money supply to rise.
B) the money supply to remain constant.
C) the money supply to fall.
D) checkable deposits to rise.
Answer: C
2) Everything else held constant, a decrease in the required reserve ratio on checkable deposits
will mean
A) a decrease in the money supply.
B) an increase in the money supply.
C) a decrease in checkable deposits.
D) an increase in discount loans.
Answer: B
3) Everything else hed constant, an increase in the required reserve ratio on checkable deposits
causes the M1 money multiplier to _____ and the money supply to _____.
A) decrease; increase
B) increase; increase
C) decrease; decrease
D) increase; decrease
Answer: C
4) Everything else held constant, a decrease in the required reserve ratio on checkable deposits
causes the M1 money multiplier to _____ and the money supply to _____.
Answer: B
5) Assuming initially that r = 10%, c = 40%, and e = 0, an increase in r to 15% causes the M1
money multiplier to _____, everything else held constant.
A) increase from 2.55 to 2.8
B) decrease from 2.8 to 2.55
C) increase from 1.82 to 2
D) decrease from 2 to 1.82
Answer: B
6) Assuming initially that r = 10%, c = 40%, and e = 0, a decrease in r to 5% causes the M1 money
multiplier to _____, everything else held constant.
C) increase from 2 to 2.22
D) decrease from 2.22 to 2
Answer: A
7) Everything else held constant, an increase in the currency-checkable deposit ratio will mean
A) an increase in currency in circulation and an increase in the money supply.
B) an increase in money supply but no change in reserves.
C) a decrease in the money supply.
D) an increase in currency in circulation but no change in the money supply.
Answer: C
8) Everything else held constant, a decrease in the currency-checkable deposit ratio will mean
A) an increase in currency in circulation and an increase in the money supply.
B) an increase in money supply.
C) a decrease in the money supply.
D) an increase in currency in circulation but no change in the money supply.
Answer: B
9) Everything else held constant, an increase in the currency ratio causes the M1 money
multiplier to _____ and the money supply to _____.
B) increase; decrease
D) increase; increase
Answer: C
10) Everything else held constant, a decrease in the currency ratio causes the M1 money multiplier
to _____ and the money supply to _____.
Answer: B
11) Assuming initially that r = 10%, c = 40%, and e = 0, an increase in c to 50% causes the M1
C) increase from 2.33 to 2.8
D) decrease from 2.8 to 2.33
Answer: B
12) Assuming initially that r = 10%, c = 40%, and e = 0, an decrease in c to 30% causes the M1
Answer: A
13) Every thing else held constant, a decrease in the excess reserves ratio causes the M1 money
Answer: B
14) Everything else held constant, an increase in the excess reserves ratio causes the M1 money
Answer: C
15) Assuming initially that r = 15%, c = 40%, and e = 5%, a decrease in e to 0% causes the M1
Answer: A
16) Assuming initially that r = 15%, c = 40%, and e = 5%, an increase in e to 10% causes the M1
Answer: B
17) The excess reserves ratio is _____ related to expected deposit outflows, and is _____ related to
the market interest rate.
A) negatively; negatively
B) negatively; positively
C) positively; negatively
D) positively; positively
Answer: C
18) The money supply is _____ related to expected deposit outflows, and is _____ related to the
market interest rate.
Answer: B
19) The money multiplier is

A) negatively related to high-powered money.
B) positively related to the excess reserves ratio.
C) negatively related to the required reserve ratio.
D) positively related to holdings of excess reserves.
Answer: C
20) What factors determine a bankʹs holdings of excess reserves? How does a change in each factor
affect excess reserves, the money multiplier, and the money supply?
Answer: An increase in market interest rates reduces excess reserves because banks profit from
increased lending. An increase in expected deposit outflows increases excess reserves.
An increase in interest rates reduces excess reserves, increasing the multiplier and the
money supply. An increase in expected outflows increases excess reserves, reducing the
multiplier and the money supply.
21) Explain two developments in recent years that have led to the decreasing importance of
reserve requirements in determining the money multiplier and the money supply.
Answer: The first is the sweep account. Sweep accounts are two accounts tied together, usually a
checking account and a money market fund account. At the end of each business day,
balances over a certain amount in the checking account are swept into the MMF
account. This has led to lower checking account balances and less required reserves,
since reserve requirements are only applied to checkable deposit accounts.
The second is the increased availability of ATMs. Banks have found that they need more
cash to supply the increased number of ATMs. Hence, this increased vault cash means
that banks are holding more excess reserves. A change in the reserve requirements will
not alter banksʹ behavior, as long as the change is less than the extra vault cash now
held by banks.
Ques Status: New
14.3 Additional Factors That Determine the Money Supply
1) The Fed does not tightly control the monetary base because it does not completely control
A) open market purchases.
B) open market sales.
C) borrowed reserves.
D) the discount rate.
Answer: C
2) Subtracting borrowed reserves from the monetary base obtains

A) reserves.
B) high-powered money.
C) the nonborrowed monetary base.
D) the borrowed monetary base.
Answer: C
3) The relationship between borrowed reserves, the nonborrowed monetary base, and the
monetary base is
A) MB = MB n - BR.
B) BR = MB n - MB.
C) BR = MB - MB n .
D) MB = BR - MB n .
Answer: C
4) Recognizing the distinction between borrowed reserves and the nonborrowed monetary base,
the money supply model is specified as
A) M = m × (MBn - BR).
B) M = m × (MBn + BR).
C) M = m + (MBn - BR).
D) M = m - (MBn + BR).
Answer: B
5) An increase in the nonborrowed monetary base, everything else held constant, will cause:
A) the money supply to fall.
B) the money supply to rise.
C) no change in the money supply.
D) demand deposits to fall.
Answer: B
6) The money supply is ________ related to the nonborrowed monetary base, and ________
related to the level of borrowed reserves.
A) positively; negatively
B) negatively; not
C) positively; positively
D) negatively; negatively
Answer: C
7) The amount of borrowed reserves is ________ related to the discount rate, and is ________
related to the market interest rate.
Answer: B
8) A ________ in market interest rates relative to the discount rate will cause discount borrowing
to ________.
A) fall; increase
B) rise; decrease
C) rise; increase
D) fall; remain unchanged
Answer: C
9) Explain the complete formula for the M1 money supply, and explain how changes in required
reserves, excess reserves, the currency ratio, the nonborrowed base, and borrowed reserves
affect the money supply.
1+c
Answer: The formula is M = × (MBn + BR). The formula indicates that the money supply
r+c+ e
is the product of the multiplier times the base. Increases in any of the multiplier
components, required reserves, r; excess reserves, e; or the currency ratio, c; reduce the
multiplier and the money supply. Increases in the nonborrowed base and borrowed
reserves both increase the base and the money supply.
14.4 Overview of the Money Supply Process
1) In the model of the money supply process, the Federal Reserveʹs role in influencing the money
supply is represented by
A) both the required reserve ratio and the market interest rate.
B) the required reserve ratio, nonborrowed reserves, borrowed reserves, and the market
interest rate.
C) only borrowed reserves.
D) only nonborrowed reserves.
Answer: B
Ques Status: New
2) In the model of the money supply process, the depositorʹs role in influencing the money
supply is represented by
A) only the currency ratio.
B) both the currency ratio and excess reserve ratio.
C) the currency ratio, excess reserve ratio, and the market interest rate.
D) only the market interest rate.
Answer: C
Ques Status: New
3) In the model of the money supply process, the bankʹs role in influencing the money supply
process is represented by
A) only the excess reserve ratio.
B) both the excess reserve ratio and the market interest rate.
C) only the currency ratio.
D) only borrowed reserves.
Answer: B
Ques Status: New
4) In the model of the money supply process, borrowers from banksʹ role in influencing the
money supply is represented by
A) only market interest rates.
B) both the excess reserve ratio and the market interest rate.
C) only the currency ratio.
D) both borrowed reserves and the market interest rate.
Answer: A
Ques Status: New
5) All else constant, a rise in market interest rates leads to a

A) rise in excess reserves and a rise in the money supply.
B) rise in borrowed reserves and a rise in the money supply.
C) fall in excess reserves and a fall in the money supply.
D) fall in borrowed reserves and a rise in the money supply.
Answer: B
6) Over the long run the primary determinant of movements in the money supply is the
A) currency ratio.
B) excess reserves ratio.
C) required reserve ratio.
D) nonborrowed base.
Answer: D
7) Over short time periods, changes in the ________ can have a major impact on the money
supply.
A) currency ratio
B) excess reserve ratio
C) required reserve ratio
D) borrowed base
Answer: A
Ques Status: New
8) During the bank panics of the Great Depression the currency ratio
A) increased sharply.
B) decreased sharply.
C) increased slightly.
D) decreased slightly.
Answer: A
9) During the bank panics of the Great Depression the excess reserve ratio
A) increased sharply.
B) decreased sharply.
C) increased slightly.
D) decreased slightly.
Answer: A
Ques Status: New
10) In the early 1930s, the currency ratio rose, as did the level of excess reserves. Money supply
analysis predicts that, everything else held constant, the money supply should have
A) risen.
B) fallen.
C) remain unchanged.
D) either risen, fallen, or remain unchanged
Answer: B
11) The monetary base increased by 20% during the contraction of 1929-1933, but the money
supply fell by 25%. Explain why this occurred. How can the money supply fall when the base
increases?
Answer: The banking crisis caused the public to fear for the safety of their deposits, increasing
both the currency ratio and bank holdings of excess reserves in anticipation of deposit
outflows. Both of these changes reduce the money multiplier and the money supply. In
this case, the fall in the multiplier due to increases of currency and excess reserves more
than offset the increase in the base, causing the money supply to fall.
14.5 Appendix: The M2 Money Multiplier
1) The equation that represents M2 in the model of the money supply process is
A) M2 = C + D
B) M2 = C + D + T - MMF
C) M2 = C + D - T + MMF
D) M2 = C + D + T + MMF
Answer: D
Ques Status: New
2) In the model of the money supply process for M2, the relationship between checkable deposits
and the M2 money supply is represented by
1
A) D = × M2
1 + c + t + mm
B) D = (1 + c + t + mm) × M2
1
C) M2 = ×D
r + c + t + mm
r + c + t + mm
D) M2 =
D
Answer: A
Ques Status: New
3) The M2 money supply is represented by

1 + c + t + mm
A) M2 = × MB
r+ e+ c
1 + c + t + mm 1
B) M2 = ×
r+ e+ c MB
1 + c + t + mm
C) MB = × M2
r+ e+ c
r+ e+ c 1
D) MB = ×
1 + c + t + mm M2
Answer: A
Ques Status: New
4) The M2 money multiplier is

A) negatively related to high-powered money.
B) positively related to the time deposit ratio.
C) positively related to the required reserve ratio.
D) positively related to the excess reserves ratio.
Answer: B
5) Everything else held constant, an increase in the currency ratio will mean ________ in the M2
money multiplier and ________ in the M2 money supply.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
Answer: D
6) Everything else held constant, a decrease in the currency ratio will mean ________ in the M1
money multiplier and ________ in the M2 money multiplier.
Answer: A
7) Everything else held constant, an increase in the required reserve ratio will mean ________ in
the M2 money multiplier and ________ in the M2 money supply.
Answer: D
8) Everything else held constant, an increase in the required reserve ratio will result in ________
in M1 and ________ in M2.
Answer: D
9) Everything else held constant, an increase in the time deposit ratio will mean ________ in the
M2 money multiplier and ________ in the M2 money supply.
Answer: A
10) Everything else held constant, an increase in the time deposit ratio will result in ________ in
the M1 money multiplier and ________ in the M2 money multiplier.
B) no change; an increase
C) a decrease; a decrease
D) no change; a decrease
Answer: B
11) Everything else held constant, an increase in the money market fund ratio will mean ________
in the M2 money multiplier and ________ in the M2 money supply.
Answer: A
12) Everything else held constant, an increase in the money market fund ratio will result in
________ in the M1 money multiplier and ________ in the M2 money multiplier.
Answer: B
13) Everything else held constant, an increase in the excess reserve ratio will mean ________ in the
M2 money multiplier and ________ in the M2 money supply.
Answer: D
Ques Status: New
14) Everything else held constant, an increase in the excess reserve ratio will mean ________ in the
M1 money multiplier and ________ in the M2 money multiplier.
Answer: C
Ques Status: New
14.6 Web Appendix: Explaining the Behavior of the Currency Ratio
1) Factors causing an increase in currency holdings include

A) an increase in the interest rates paid on checkable deposits.
B) an increase in the cost of acquiring currency.
C) a decrease in bank panics.
D) an increase in illegal activity.
Answer: D
2) Part of the increase in currency holdings in the 1960s and 1970s can be attributed to
A) increases in income tax rates.
B) the switch from progressive to proportional income taxes.
C) the adoption of regressive taxes.
D) bracket creep due to inflation and progressive income taxes.
Answer: D
3) Everything else held constant, an increase in wealth will cause the holdings of checkable
deposits to the holdings of currency to ________ and the currency ratio will ________.
A) increase; increase
C) decrease; increase
D) decrease; decrease
Answer: B
Ques Status: New
4) Everything else held constant, an increase in the interest rate paid on checkable deposits will
cause ________ in the amount of checkable deposits held relative to currency holdings and
________ in the currency ratio.
Answer: B
Ques Status: New
5) The increase in the availability of ATMʹs has caused the cost of acquiring currency to ________
which will cause the currency ratio to ________, everything else held constant.
A) increase; increase
C) decrease; increase
D) decrease; decrease
Answer: C
Ques Status: New
6) The steepest increase in the currency ratio since 1892 occurred during
A) World War II.
B) the Great Depression.
C) the interwar years.
D) the past twenty years.
Answer: B
7) The factor accounting for the steepest rise in the currency ratio since 1892 is
A) taxes.
B) bank panics.
C) illegal activity.
D) an increase in wealth.
Answer: B
8) The increase in the currency ratio during World War II was due to
A) bank panics.
B) a drop in the rate of interest paid on checking deposits.
C) the spread of ATMs.
D) high taxes and illegal activities.
Answer: D

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Chapter 14

Determinants of the Money Supply

14.1 The Money Supply Model and the Money Multiplier

4) The formula linking the money supply to the monetary base is

17) The formula for the M1 money multiplier is

14.2 Factors That Determine the Money Multiplier

19) The money multiplier is

14.3 Additional Factors That Determine the Money Supply

2) Subtracting borrowed reserves from the monetary base obtains

14.4 Overview of the Money Supply Process

5) All else constant, a rise in market interest rates leads to a

14.5 Appendix: The M2 Money Multiplier

3) The M2 money supply is represented by

4) The M2 money multiplier is

14.6 Web Appendix: Explaining the Behavior of the Currency Ratio

1) Factors causing an increase in currency holdings include

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