Money Creation and The Federal Reserve
Multiple Choice Questions
After watching the Money Creation and The Federal Reserve video lecture, consider the question(s) below. Then “submit” your response.
Question
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After watching the Money Creation and The Federal Reserve video lecture, consider the question(s) below. Then “submit” your response.
Question
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Question
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Question
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Short Answer/Discussion Questions
After watching the Money Creation and The Federal Reserve video lecture, consider the question(s) below. Then “submit” your response.
Question
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Suggested solution: The reserve requirement is the proportion of a deposit that a bank must keep on hand. The balance of the deposit can be loaned to borrowers. With a reserve requirement of 20%, a $1,000 deposit can become both the initial deposit of $1,000 and an $800 loan. The initial $1,000 deposit has become a total of $1,800 of money. (Two hundred dollars of the deposit is required to satisfy the reserve requirement.) If the reserve requirement were increased the potential amount of money that can be created would be lower.
Question
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Suggested solution: The Fed can use its ability to create funds electronically to buy bonds from banks. This purchase activity has the effect of creating money in the same ways as when a bank’s deposits increase. In addition, the purchase activity has the effect of lowering interest rates in the economy. Both the increase in the money supply and the decrease in interest rates can stimulate greater levels of economic activity.
Question
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Suggested solution: An overheating economy is characterized by increasing inflation. In this case, the Fed would seek to slow down the growth of the money supply and raise interest rates to slow down economic activity. This can be accomplished by raising the reserve requirement, increasing the discount rate, and buying bonds through open market operations. These three actions will increase interest rates and discourage borrowing, slowing down the economy and reducing inflation.