var imagesLarge = "krugmanwellsmacro4-numbered_fig-ch14_fig_1,,krugmanwellsmacro4-numbered_fig-ch14_fig_5,krugmanwellsmacro4-numbered_fig-ch14_fig_6,krugmanwellsmacro4-numbered_fig-ch14_fig_9,krugmanwellsmacro4-numbered_fig-ch14_fig_10,,,,,"; var imagesXlarge = "krugmanwellsmacro4-numbered_fig-ch14_fig_4,krugmanwellsmacro4-numbered_fig-ch14_fig_8,,,,,,,"; var pitfalls_onmargin = "krugmanwellsmacro4-ch14-pitfalls-box-WHATSNOTINTHEMONEYSUPPLY,,,," /*** CYU answers ***/ xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-1-1a'] = "
The defining characteristic of money is its liquidity: how easily it can be used to purchase goods and services. Although a gift card can easily be used to purchase a very defined set of goods or services (the goods or services available at the store issuing the gift card), it cannot be used to purchase any other goods or services. A gift card is therefore not money, since it cannot easily be used to purchase all goods and services.
"; xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-1-2a'] = "Again, the important characteristic of money is its liquidity: how easily it can be used to purchase goods and services. M1, the narrowest definition of the money supply, contains only currency in circulation, traveler’s checks, and checkable bank deposits. CDs aren’t checkable—and they can’t be made checkable without incurring a cost because there’s a penalty for early withdrawal. This makes them less liquid than the assets counted in M1.
"; xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-1-3a'] = "Commodity-backed money uses resources more efficiently than simple commodity money, like gold and silver coins, because commodity-backed money ties up fewer valuable resources. Although a bank must keep some of the commodity—generally gold and silver—on hand, it only has to keep enough to satisfy demand for redemptions. It can then lend out the remaining gold and silver, which allows society to use these resources for other purposes, with no loss in the ability to achieve gains from trade.
"; xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-2-1a'] = "Even though you know that the rumor about the bank is not true, you are concerned about other depositors pulling their money out of the bank. And you know that if enough other depositors pull their money out, the bank will fail. In that case, it is rational for you to pull your money out before the bank fails. All depositors will think like this, so even if they all know that the rumor is false, they may still rationally pull their money out, leading to a bank run. Deposit insurance leads depositors to worry less about the possibility of a bank run. Even if a bank fails, the FDIC will currently pay each depositor up to $250,000 per account. This will make you much less likely to pull your money out in response to a rumor. Since other depositors will think the same, there will be no bank run.
"; xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-2-2a'] = "The aspects of modern bank regulation that would frustrate this scheme are capital requirements and reserve requirements. Capital requirements mean that a bank has to have a certain amount of capital—the difference between its assets (loans plus reserves) and its liabilities (deposits). So the con artist could not open a bank without putting any of his own wealth in because the bank needs a certain amount of capital—that is, it needs to hold more assets (loans plus reserves) than deposits. So the con artist would be at risk of losing his own wealth if his loans turn out badly.
"; xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-3-1a'] = "Since they only have to hold $100 in reserves, instead of $200, banks now lend out $100 of their reserves. Whoever borrows the $100 will deposit it in a bank, which will lend out $100 × (1 − rr) = $100 × 0.9 = $90. Whoever borrows the $90 will put it into a bank, which will lend out $90 × 0.9 = $81, and so on. Overall, deposits will increase by $100/0.1 = $1,000.
"; xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-3-2a'] = "Silas puts $1,000 in the bank, of which the bank lends out $1,000 × (1 − rr) = $1,000 × 0.9 = $900. Whoever borrows the $900 will keep $450 in cash and deposit $450 in a bank. The bank will lend out $450 × 0.9 = $405. Whoever borrows the $405 will keep $202.50 in cash and deposit $202.50 in a bank. The bank will lend out $202.50 × 0.9 = $182.25, and so on. Overall, this leads to an increase in deposits of $1,000 + $450 + $202.50 + . . . But it decreases the amount of currency in circulation: the amount of cash is reduced by the $1,000 Silas puts into the bank. This is offset, but not fully, by the amount of cash held by each borrower. The amount of currency in circulation therefore changes by −$1,000 + $450 + $202.50 + . . . The money supply therefore increases by the sum of the increase in deposits and the change in currency in circulation, which is $1,000 − $1,000 + $450 + $450 + $202.50 + $202.50 + . . . and so on.
"; xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-4-1a'] = "An open-market purchase of $100 million by the Fed increases banks’ reserves by $100 million as the Fed credits their accounts with additional reserves. In other words, this open-market purchase increases the monetary base (currency in circulation plus bank reserves) by $100 million. Banks lend out the additional $100 million. Whoever borrows the money puts it back into the banking system in the form of deposits. Of these deposits, banks lend out $100 million × (1 − rr) = $100 million × 0.9 = $90 million. Whoever borrows the money deposits it back into the banking system. And banks lend out $90 million × 0.9 = $81 million, and so on. As a result, bank deposits increase by $100 million + $90 million + $81 million + . . . = $100 million/rr = $100 million/0.1 = $1,000 million = $1 billion. Since in this simplified example all money lent out is deposited back into the banking system, there is no increase of currency in circulation, so the increase in bank deposits is equal to the increase in the money supply. In other words, the money supply increases by $1 billion. This is greater than the increase in the monetary base by a factor of 10: in this simplified model in which deposits are the only component of the money supply and in which banks hold no excess reserves, the money multiplier is 1/rr = 10.
"; xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-5-1a'] = "The Panic of 1907, the S&L crisis, and the crisis of 2008 all involved losses by financial institutions that were less regulated than banks. In the crises of 1907 and 2008, there was a widespread loss of confidence in the financial sector and collapse of credit markets. Like the crisis of 1907 and the S&L crisis, the crisis of 2008 exerted a powerful negative effect on the economy.
"; xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-5-2a'] = "The creation of the Federal Reserve failed to prevent bank runs because it did not eradicate the fears of depositors that a bank collapse would cause them to lose their money. The bank runs eventually stopped after federal deposit insurance was instituted and the public came to understand that their deposits were now protected.
"; xBookUtils.showAnswers['krugmanwellsmacro4-cyu-14-5-3a'] = "The balance sheet effect occurs when asset sales cause declines in asset prices, which then reduce the value of other firms’ net worth as the value of the assets on their balance sheets declines. In the vicious cycle of deleveraging, the balance sheet effect on firms forces their creditors to call in their loan contracts, forcing the firms to sell assets to pay back their loans, leading to further asset sales and price declines. Because the vicious cycle of deleveraging occurs across different firms and no single firm can stop it, it is necessary for the government to step in to stop it.
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