Q: Suppose the central bank buys $500 million in government bonds from the public. If the reserve ratio is 0.2 and all money is deposited in banks, by how much could the money supply potentially increase?

$$2.5$$ billion, since $$\500$$\text{ million} \times \frac{1}{0.2} = \$$2.5\text{ billion}$$

Q: A country has $$\2$$,000$$ in currency held by the public and $$\$$8,000 in $$demand deposits. If the required reserve ratio is $$0.1$$, what is the maximum potential money supply?

$$\100$$,000$$, since $$\text{Money Supply} = \frac{\text{Currency} + \text{Deposits}}{\text{Reserve Ratio}} = \frac{2,000 + 8,000}{0.1} = 100,000$

Question 1

Which of the following best describes the three principal uses of money in a modern economy?

Accepted Answer

Medium of exchange, unit of account, store of value

Question 2

Suppose the central bank lowers the required reserve ratio from 20% to 10%. If the monetary base remains unchanged, what is the effect on the money supply, assuming no change in currency holdings?

Accepted Answer

The money supply increases because the money multiplier increases

Question 3

Which of the following assets is included in M2 but NOT in M1?

Accepted Answer

Savings deposits

Question 4

If the nominal interest rate increases, what happens to the quantity of money demanded, all else equal?

Accepted Answer

It decreases because the opportunity cost of holding money rises

Question 5

Suppose the central bank buys $500 million in government bonds from the public. If the reserve ratio is 0.2 and all money is deposited in banks, by how much could the money supply potentially increase?

Accepted Answer

$$2.5$$ billion, since $$\500$$	ext{ million} 	imes \frac{1}{0.2} = \$$2.5	ext{ billion}$$

Question 6

Which of the following would cause the money demand curve to shift to the right?

Accepted Answer

An increase in real GDP

Question 7

If the central bank wants to decrease the money supply, which of the following actions should it take?

Accepted Answer

Sell government bonds in the open market

Question 8

A country has $$\2$$,000$$ in currency held by the public and $$\$$8,000 in $$demand deposits. If the required reserve ratio is $$0.1$$, what is the maximum potential money supply?

Accepted Answer

$$\100$$,000$$, since $$	ext{Money Supply} = \frac{	ext{Currency} + 	ext{Deposits}}{	ext{Reserve Ratio}} = \frac{2,000 + 8,000}{0.1} = 100,000$

Question 9

If the central bank increases capital recycling (makes more short-term loans to commercial banks), what is the likely effect on the money supply and nominal interest rate?

Accepted Answer

Money supply increases; nominal interest rate decreases

Question 10

Suppose the money demand function is $$MD = L(Y, i)$$, where $$Y is $$real income and $$i is $$the nominal interest rate. If $$Y$$ increases and $$i$$ remains constant, what happens to the equilibrium nominal interest rate in the money market?

Accepted Answer

It increases because the money demand curve shifts right, raising the equilibrium interest rate

Question 11

Which of the following best describes the effect of an open market sale of government bonds by the central bank?

Accepted Answer

It decreases the monetary base and reduces the money supply

Question 12

If the central bank wants to maintain a fixed exchange rate and the domestic currency is under upward pressure, what action should it take and what is the effect on the money supply?

Accepted Answer

Sell domestic currency and buy foreign currency, increasing the money supply

Question 13

A new financial technology allows people to pay for goods using their smartphones, reducing the need to carry cash. What is the likely effect on the money demand curve and equilibrium nominal interest rate?

Accepted Answer

Money demand decreases; equilibrium nominal interest rate falls

Question 14

If the nominal interest rate is below the equilibrium value, what will happen in the money market?

Accepted Answer

The quantity demanded of money exceeds the quantity supplied, asset prices fall, and the nominal interest rate rises

Question 15

Suppose a country has $$\1$$,000$$ in currency, all held by banks as reserves. The required reserve ratio is 0.2$ and the reserve ratio is 0.25$. What is the money supply?

Accepted Answer

$$\4$$,000$$, since $$	ext{Money Supply} = \frac{	ext{Bank Reserves}}{	ext{Reserve Ratio}} = \frac{1,000}{0.25} = 4,000$

Question 16

If Judy transfers $$\1$$,000$ from her savings account to her demand deposit account, what happens to M1 and M2?

Accepted Answer

M1 increases; M2 remains unchanged

Question 17

Which of the following is the correct formula for the money multiplier ($$m) in $$terms of currency-deposit ratio ($$C/D) $$and reserve-deposit ratio ($$R/D$$)?

Accepted Answer

$$m = \frac{C/D + 1}{C/D + R/D}$$

Question 18

If the central bank sells $$\100$ million in foreign currency, what is the likely effect on the domestic money supply and the exchange rate?

Accepted Answer

Money supply decreases; domestic currency appreciates

Question 19

If the quantity supplied of money exceeds the quantity demanded, what will people do and what is the effect on asset prices and the nominal interest rate?

Accepted Answer

People buy other assets, asset prices rise, and the nominal interest rate falls

Money and Monetary Policy: Study Notes for Macroeconomics

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