Chapter 21

1. a. A U.S. penny is regarded as money in the American economy since it is a

commonly used medium of exchange and is issued by the government.

b. A Mexican peso: Because it is not often used as a medium of exchange in the

United States and is issued by the Mexican government, it is not regarded as
money in the American economy.

c. A Picasso painting: Since it is not a government-issued currency and is not

commonly used as a means of exchange, it is not regarded as money in the
American economy.

d. A plastic credit card: Because it provides a means of exchange, this is regarded

as money in the American economy. Despite not being issued by the government,
it is frequently accepted as payment by businesses. Because credit cards allow
users to make purchases and settle the balance at a later time, they also function as
a store of value.

2. a. The Fed buys bonds in open-market operations. INCREASES MONEY

SUPPLY
b. The Fed reduces the reserve requirement. INCREASES MONEY SUPPLY
c. The Fed increases the interest rate it pays on reserves. REDUCES MONEY
SUPPLY
d. Citibank repays a loan it had previously taken from the Fed. REDUCES
MONEY SUPPLY
e. After a rash of pickpocketing, people decide to hold less currency. REDUCES
MONEY SUPPLY
f. Fearful of bank runs, bankers decide to hold more excess reserves. REDUCES
MONEY SUPPLY
g. The FOMC increases its target for the federal funds rate. REDUCES MONEY
SUPPLY
Explanation:
a. The Fed buys bonds in open-market operations: This will INCREASE money
supply because the Fed will pay cash to bond holders in return and the implication
of that action is the injecting money into circulation

b. The reserve requirement is lowered by the Fed. Because it suggests that

commercial banks are being encouraged to retain less money in reserve and pay
out the remainder, which means more money in circulation, this action will
INCREASE the amount of money in circulation.

c. The Federal Reserve raises the interest rate on reserves it pays. Because it
suggests that commercial banks will see such a rise in interest as an incentive to
save money rather than pay it out, this action will actually DECREASE the amount
of money in circulation. Commercial banks are being urged to maintain larger
reserves, which will reduce the amount of money in circulation.
d. Citibank pays back a previous Federal Reserve loan. Because it implies that the
commercial bank (Citibank) will have to pay such a government loan with the
money in circulation, this action will REDUCE the amount of money in
circulation.

e. Following a wave of pickpocketing, many opt to carry less cash. Because it

suggests that consumers will hold less money and deposit more of it in banks, this
action will REDUCE the amount of money in circulation. The amount of money in
circulation will decrease in proportion to this decline in demand for cash.
f. Bankers decide to maintain greater surplus reserves because of fear of bank runs.
Due to the assumption that commercial banks would hoard more money rather than
distribute it, this action will actually DECREASE the amount of money in
circulation. There will be less money in circulation as a result of this reserve
accumulation.

g. The Federal Open Market Committee raises the federal funds rate goal it has set.
This action will SQUEAK commercial banks to use the current cash in circulation
to meet their reserve requirement, which will mean that banks will have less
money to pay out as cash. This action will REDUCE the amount of money in
circulation because it implies that commercial banks can hardly borrow to meet the
Fed's reserve requirement.
3. Following the loan repayment, the T-accounts indicate a decline in both your
uncle's checking account and TNB's loan receivables. The debt is fulfilled; thus,
your uncle's wealth stays the same even if his checking account balance drops.

Explain:
Both the amount in your uncle's checking account and the amount of TNB's loan
receivables will decline according to the T-accounts for this transaction. The
amount drops by $100 when your uncle writes this $100 check out of his TNB
checking account. Since TNB has now paid off the $100 loan receivable, that sum
will also be deducted from their accounts.

As for your uncle's wealth, it has not changed because although his checking
account balance has reduced, he no longer owes the $100 loan, which cancels out
the reduction of his checking account balance. Therefore, he is in the same
financial position as before paying off the loan.
4. a. T-account for BSB:
Assets:
- Reserves: 25 million (10% of 250 million)
- Loans: 225 million

Liabilities:
- Deposits: 250 million

b. New T-account for BSB:

Assets:
- Reserves: 15 million (25 million - 10 million withdrawal)
- Loans: 225 million
Liabilities:
- Deposits: 240 million (250 million - 10 million withdrawal)
c. Other banks will experience shrinkage as a result of BSB's move. The money
supply is reduced when BSB lowers the total number of loans outstanding in order
to reinstate its reserve ratio. Consequently, a reduction in the amount of money
available for other banks to lend might result in a decline in loans and overall
economic activity.

d. Because lowering the quantity of loans outstanding may have a detrimental

impact on the bank's profitability and capacity to produce interest revenue, it may
be challenging for BSB to take the action outlined in paragraph (b). In addition,
BSB runs the danger of creating economic instability if it cuts loans too rapidly.
Attracting new deposits is another option for BSB to go back to its initial reserve
ratio. BSB can raise its reserves without having to lower the amount of loans that
are outstanding by encouraging people and companies to deposit money into their
bank. This may be accomplished by running marketing efforts, giving competitive
loan rates, or enticing clients with extra services.

5. The bank which keep some portion of money as mandatory deposit and lends
rest of money called Frictional Reserve banking.
How to calculate the frictional reserve banking (with help of example)?
Let I have deposit $100 in my bank account. Banks store 10% of money that is
only $10 bank keep rest are lends by bank. The balance sheet shows that bank
increase the money supply by $90. After the loan was made money supply was
$190 as compared to $100. In second time loan banks lends $81 so the total money
supply is $81+$190. In this way the whole process will go on until the loanable
amount become zero.
6. (a) The balance sheet of Happy bank is as follows:
Asset Liability
Loan $900 Capital $200
Reserve $100 Deposit $800
$1000 $1000
(b) Leverage ratio is calculated as follows:
Leverage ratio = Total assets / Capital = 1000 / 200 = 5
(c), The bad loan of 10% reduces loans of bank by $90. Therefore, bank loan is
810. Bad loan is loss to bank; therefore, it reduces capital of bank. Therefore,
bank's capital is 110.
Asset Liability
Loan $810 Capital $110
Reserve $100 Deposit $800
$910 $910

(d) Bank's total asset decline from $1000 to $910.

1000−910
Change in bank's assets = 1000
x 100 = 9%

7. $100 million; $10 million

Explanation:
Required reserve ratio (r) = 10%
Worth of bond = $10,000,000
The smallest increase can be thought of as being the $10 million generated from
open market operation and could be held by the bank as reserve.
To calculate the largest increase in deposit:
Money multiplier * deposit (worth of bond)
Money multiplier = (1 / reserve ratio)
Money multiplier = (1 / 0.1) = 10
Increase in deposit = 10 * $10,000,000 = $100,000,000 ($100 million)

8. Based on the information given in the question, the reserve ratio is given as 5%,
then the money multiplier will be:
= 1 / reserve requirement
= 1/5%
= 1 / 0.05
= 20.
Therefore, the money multiplier will increase by 20.
Then, the Money supply will be calculated as:
= amount x money multiplier
= 2000 x 20
= 40000
Therefore, the increase in the money supply will be $40000.
In this case, if the FED purchases $2000 worth of bonds, it'll expand the money
supply more.

9. a) Calculate the money multiplier with a required reserve ratio of 10% and no
excess reserves as follows:
Money multiplier = 1 / 0.10 =10
If the Fed sells $1 million of bonds, reserves will decline by $1 million and the
money supply will contract by 10× $1 million = $10 million

b) Banks might wish to hold excess reserves if they need to hold the reserves for
their day- to-day operations, such as paying other banks for customers'
transactions, making change, cashing paychecks, and so on.
If banks increase the excess reserves such that there is no overall change in the
total reserve ratio, then the money multiplier does not change and there is no effect
on the money supply.

10. (a) 10; $1000 billion

(b) 5; decreases to $500 billion
Explanation:
(a) Since the reserve ratio is 10%,
the money multiplier will be:
= 1 ÷ Required reserve ratio
= 1 ÷ 0.1
= 10
Money Supply = Total Reserves × (Money Multiplier)
= 100 × 10
= $1000 billion
(b) Since the new reserve ratio is 20%,
the new money multiplier will be:
= 1 ÷ Required reserve ratio
= 1 ÷ 0.2
=5
New reserves for money supply of $1000 billion = $1000 ÷ 5
= $200 billion
Change in reserves = 200 - 100
= $100 billion
New money supply to maintain $100 billion reserves:
= 100 × 5
= $500 Billion
Change in money supply = 1000 - 500
= $500 billion
11. Open market operations is a monetary policy instrument used by the central
bank of a nation to control the money supply in an economy. So, if Fed wants to
contract the money supply, then it must sell the bonds in the market.
Reserve requirement = 20%
Multiplier = 1 ÷ Reserve requirement
= 1 ÷ 20%
 = 20
So, in order to contract the money supply by $40 million, the amount of bonds
needs to be sold will be $40/20 = $2 million.

12. Answer:
(a) $2,000
(b) $2,000
(c) $2,000
(d) $20,000
(e) $3,636
Explanation:
Given that,
Number of bills = 2,000
Worth of each bill = $1
(a) If people hold all money as currency, then the quantity of money is determined
as follows:
= Number of bills × Worth of each bill
= 2,000 × $1
= $2,000
(b) If people hold all money as demand deposits and banks maintain 100 percent
reserves,
Reserve requirement ratio = Reserves / Deposits = 2000 / 2000 = 1
Money multiplier = 1/ Reserve requirement ratio
= 1/1
=1
Quantity of money:
= Money multiplier × Demand deposits
= 1 × $2,000
= $2,000
(c) If people hold equal amounts of currency and demand deposits and banks
maintain 100 percent reserves,
Therefore,
Currency = $1,000
Demand deposits = $1,000
Quantity of Money:
= Currency with public + Demand deposits
= $1,000 + $1,00
= $2,000
(d) If people hold all money as demand deposits and banks maintain 10 percent
reserves,
Money multiplier = 1/ Reserve requirement ratio
= 1/0.1
= 10
Quantity of money:
= Money multiplier × Demand deposits
= 10 × $2,000
= $20,000
(e) If people hold equal amounts of currency and demand deposits and banks
maintain 10 percent reserves,
Now, we know that
Currency = Demand deposits
Banks maintain 10 percent reserves,
C = $20,000 – 10C
11C = $20,000
C = 20,000 / 11 = $1,818.182
Therefore, the currency = $1,818.182
Quantity of money:
= Currency + Demand deposits
= $1,818+ $1,818
= $3,636