1.The most important tool the Fed has to control the money supply is
a. changing the federal funds rate.
b. changing the required reserve ration.
c. open market operations.
d. changing the discount rate
2. Banks use their excess reserves to
a. make new loans to customers.
b. show their customers that they are responsible and will be able to turn money over when demanded.
c. satisfy the government requirement that a certain percentage of transaction deposits be kept on hand.
d. make other banks think that this bank is more prosperous than it really is.
3. If a bank discovers it has insufficient required reserves, it can do all of the following EXCEPT
a. call in loans.
b. change the required reserve ratio.
c. borrow from the federal funds market.
d. borrow from the Fed.
4.The more people decide to hold currency, the
a. larger the money supply.
b. greater control the Fed has over the money supply.
c. larger the actual money multiplier.
d. smaller the actual money multiplier.
5. If depository insurance exists, bank managers may make riskier loans than they would have otherwise, which is an example of
a. irrational behavior.
b. moral hazard.
c. adverse selection.
d. regulatory lag
Question 5. Answer is B. Moral Hazard
1. The most important tool the Fed has to control the money supply is "c. open market operations." To explain how to get this answer, you can understand that open market operations involve the buying and selling of government securities in the open market. By buying government securities, the Fed injects money into the banking system, increasing the money supply. Conversely, by selling government securities, the Fed decreases the money supply. Hence, open market operations are a crucial tool for controlling the money supply.
2. Banks use their excess reserves to "a. make new loans to customers." To understand this, it is important to know that excess reserves are the reserves held by banks above the required reserve ratio. Banks can lend out these excess reserves to customers, thereby creating new loans and increasing the circulation of money in the economy.
3. If a bank discovers it has insufficient required reserves, it can do all of the following EXCEPT "b. change the required reserve ratio." The other options are valid actions that a bank can take:
- Calling in loans: The bank can collect outstanding loans to increase its reserves.
- Borrowing from the Federal Funds market: Banks can borrow from other banks in the Federal Funds market to increase their reserves.
- Borrowing from the Fed: If necessary, banks can borrow directly from the Federal Reserve to meet their reserve requirements. However, banks cannot change the required reserve ratio themselves; it is determined by the central bank (the Fed).
4. The more people decide to hold currency, the "d. smaller the actual money multiplier." To understand this, the concept of the money multiplier is relevant. The money multiplier refers to the ratio of the total money supply to the monetary base (reserves). When people decide to hold more currency (in their wallets or bank vaults), it reduces the amount of currency available for banks to lend out, thereby reducing the money multiplier. As a result, the impact and expansion of the money supply are diminished.
5. If depository insurance exists, bank managers may make riskier loans than they would have otherwise, which is an example of "b. moral hazard." To understand this, you can explain that depository insurance, such as the Federal Deposit Insurance Corporation (FDIC) in the United States, provides protection to depositors in case a bank fails. Knowing that their deposits are insured, bank managers may be inclined to take more risks because they are protected from the consequences of failure. This behavior is known as moral hazard, where the presence of insurance reduces the incentive to act responsibly and increases the willingness to take on riskier loans.