1. Describe the role required reserves play in determining how much money the banking system creates.

2. Why are checking accounts (demand deposits) considered a liability to the bank?

3. Why do leakages reduce the money multiplier from its potential?

4. What is the most common tool used by the Federal Reserve to conduct monetary policy and how does it affect interest rates?

5. For what type of borrowing do the federal funds rate and the discount rate apply? Which rate is used in more transactions in the United States?

6. Why are monetary policy lags generally shorter than fiscal policy lags?

7. The U.S. government produces billions of dollars in banknotes and coins for use in everyday transactions. Explain why currency alone does not represent money creation.

8. During an economic boom, banks tend to increase their willingness to lend. How does this trend influence the actual money multiplier?

9. The Federal Deposit Insurance Corporation (FDIC) insures individual bank accounts up to $250,000 per account. Does the existence of this insurance eliminate the need for reserve requirements? Does it essentially prevent “runs” on banks?

10. Many central banks in the world are independent in the sense that they are partially isolated from short-run political considerations and pressures. How is this independence attained? How important is this independence to policymaking at the Federal Reserve?

11. Alan Greenspan, a former Fed Chair, noted that “the Federal Reserve has to be independent in its actions and as an institution, because if Federal Reserve independence is in any way compromised, it undercuts our capability of protecting the value of the currency in society.” What is so important about protecting the value of the currency? How does Fed independence help?

12. The reserve requirement sets the required percentage of vault cash plus deposits with the regional Federal Reserve Banks that banks must keep for their deposits. Many banks have widespread branches and ATMs. Would the existence of branches and ATMs affect the level of excess reserves (above those required) that banks hold? Why or why not? What would be the effect on the actual money multiplier?

13. Eric Keetch offered an interesting anecdote in the Financial Times (August 12, 2009):

In a sleepy European holiday resort town in a depressed economy and therefore no visitors, there is great excitement when a wealthy Russian guest appears in the local hotel reception, announces that he intends to stay for an extended period and places a €100 note on the counter as surety while he demands to be shown the available rooms.

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While he is being shown the room, the hotelier takes the €100 note round to his butcher, who is pressing for payment.

The butcher in turn pays his wholesaler who, in turn, pays his farmer supplier.

The farmer takes the note round to his favorite “good time girl” to whom he owes €100 for services rendered. She, in turn, rushes round to the hotel to settle her bill for rooms provided on credit.

In the meantime, the Russian returns to the lobby, announces that no rooms are satisfactory, takes back his €100 note and leaves, never to be seen again.

No new money has been introduced into the local economy, but everyone’s debts have been settled.

What’s going on here? In the end, no new money was introduced into the town, but all debts were paid. Is the money multiplier infinite? How do you explain what has happened? Did local GDP increase as a result of all debts being paid?

14. Following the March 16, 2016, FOMC meeting, Fed Chair Janet Yellen announced that the federal funds rate would remain steady (around 0.5%) through the end of the year, essentially delaying the goal of raising interest rates to the long-run target of 2% to 3% for another two years. How might this announcement affect the lives of ordinary individuals, and what impact might this have on the economy?

15. Assume that First Purity Bank begins with the balance sheet below and is fully loaned-up. Answer the questions that follow.

16. Suppose that the leakage-adjusted money multiplier can be calculated using a modification of our money multiplier formula:

1/(Reserve Requirement + Excess Reserves + Cash Holdings)

where each component in the denominator is expressed as a percentage.

Suppose that the reserve requirement is 25%, but banks, on average, hold an additional 10% of their deposits as excess reserves. Further, assume that individuals and businesses choose to hold 15% of their borrowed funds in cash. Compare the potential money multiplier with the leakage-adjusted money multiplier. Does the existence of leakages make a significant impact on the ability to conduct monetary policy? Explain why or why not.

17. According to By the Numbers, during which decade did the greatest number of U.S. banks fail? During which decade did the second most number of U.S. banks fail?

18. According to By the Numbers, about how much in U.S. Treasuries did the Federal Reserve have on its balance sheet in 2005 and 2015? (Hint: Use the percentages given in each pie to calculate the values.) If the amount of U.S. Treasuries held by the Fed increased over the ten years, why did the percentage drop by so much?