Core Economics 3e

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

1. Much of the money creation in the U.S. economy is done through actions of _____ and _____.

savings banks; credit unions

the Federal Reserve; commercial banks

the U.S. Mint; the Bureau of Printing and Engraving

the stock market; the purchasers of bonds

Question

2. The portion of deposits that banks must keep on hand for day-to-day operations and other purposes is called the:

loan-to-assets ratio.

inflation protection.

reserve requirement.

banks’ profit margins.

Question

3. If the reserve requirement is 25%, how much can a bank lend from an initial $1,000 deposit of cash?

$800

$2,500

$250

$750

Question

4. The _____ enables calculation of the maximum amount of money that can be created from a dollar deposited into the banking system.

money multiplier

monetary creator

banking divisor

Fed calculator

Question

5. The actual money multiplier is lower than the theoretical maximum because of _____ in the economy.

deficits

inflation

leakages

growth

Question

6. When the economy is _____, money leakage tends to rise; this tends to slow the money creation process.

strong

weak

transparent

accelerating

Question

7. The _____ is the central bank of the United States.

Bank of America

U.S. Department of the Treasury

U.S. Bank

Federal Reserve

Question

8. The main function of a central bank is to:

assist banks in finding customers.

influence monetary policy.

print cash.

determine which banks are solvent.

Question

9. One of the Federal Reserve’s main monetary policy tools is:

the chairman/woman testifying before Congress about the state of the economy.

holding conferences with business leaders to discuss business investments.

setting the discount rate which establishes the cost to banks of borrowing from the Fed.

regulating banks to increase consumer confidence in the financial system.

Question

10. The _____ rate influences nearly all other interest rates in the economy.

recovery

home loan

borrowing

federal funds

True/False Questions

After watching the Money Creation and The Federal Reserve video lecture, consider the question(s) below. Then “submit” your response.

Question

1. Money can be created in the U.S. economy only by printing more paper money and minting more coins.

True

False

Question

2. The reserve requirement is the proportion of its deposits that a bank must keep on hand and not use to create money through making loans to borrowers.

True

False

Question

3. A foreign entity holding cash is considered a leakage in the economy.

True

False

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

1. What role does the reserve requirement play in the creation of money by banks?

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

2. Explain how the Federal Reserve’s open market operations can increase the money supply and stimulate the economy.

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

3. What might the Federal Reserve do to combat an overheating economy?

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.