Click on the letter choices to test your understanding Question 1 Fractional reserve banking is a concept Try again Banks in almost all countries of the world practice this form of banking Back ID: 1003115
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1. Test Your KnowledgeFractional Reserve BankingClick on the letter choices to test your understanding
2. Question 1Fractional reserve banking is a concept
3. Try again! Banks in almost all countries of the world practice this form of banking.Back
4. Try again!According to a common story about the origin of banking, fractional reserve banking has been practiced since the 17th century. Depositors of gold and silver coins would receive bank notes as a claim on their deposit from the depositories (banks). As bankers realized all depositors would not make claims on their gold or silver at one time, they began issuing interest bearing loans against a fraction of the gold and silver deposits. Back
5. Correct!According to a common story about the origins of banking, fractional reserve banking dates back to the 17th century. This practice enables banks to hold only a fraction of all deposits as reserves that are available for withdrawals. Banks use the remaining fraction of deposits to make new loans; charging interest on those loans. Next
6. Question 2Banks earn profits by
7. Correct!Known as the net interest spread, banks charge higher rates of interest for lending than they pay customers for interest bearing deposits. Banks earn profits through this business practice.Next
8. Try again!Increasing bank holdings of reserves and decreasing bank lending will result in higher nominal interest rates and lower levels of borrowing by businesses and individuals. This will lead to lower overall bank revenues.Back
9. Try again!The Federal Reserve charges banks interest on overnight lending, also known as the discount rate. The Federal Reserve serves as the lender of last resort to financial institutions that face financial difficulties. Back
10. Question 3The money supply includes
11. Try again!All currency in circulation is only one component of the money supply.Back
12. Try again!All currency in circulation is only one component of the money supply.Back
13. Correct!M-1, one standard measure of the money supply, includes all currency in circulation plus the demand deposits, checkable deposits, at depository institutions (financial institutions that acquire their deposits from the public, i.e. commercial banks, credit unions, savings and loan associations, and savings banks). Next
14. Question 4Required reserves are the fraction of deposits
15. Correct!In order to meet customer demands for cash withdrawals banks are required to hold a fraction of all deposits as bank reserves. This enables banks to meet the liquidity demands for their customers.Next
16. Try again!Banks earn profits by charging a higher interest rate on money loaned than the interest rate paid on deposits held. Back
17. Try again!The FDIC, the Federal Deposit Insurance Corporation, does not set the required reserve ratio which establishes the fraction of deposits that banks must hold to meet customer demands for liquidity.Back
18. Question 5The required reserve ratio
19. CorrectThe Board of Governors of the Federal Reserve has the sole authority to set the required reserve ratio thus making changes to the reserve requirements.Next
20. Try again!Based on limits that have been established by law, state governments do not have the authority to set reserve requirements.Back
21. Try again!The least commonly used tool of monetary policy is making changes to the required reserve ratio. The last time the Fed used this tool to implement an expansion of the money supply was in April 1992. Back
22. Question 6Excess reserves are
23. Try again! Excess reserves are not determined by the capacity of a bank’s vaults.Back
24. Try again! While the majority of currency in circulation is held outside the United States this currency does not represent the excess reserves banks hold. Back
25. Correct!After banks have met their reserve requirements the amount of money that is available for lending is known as excess reserves.Next
26. Question 7Which of the following is correct?
27. Correct!When the reserve requirement is lowered by the Fed banks are required to keep a smaller fraction of their deposits on reserve. This increases the amount of excess reserves that will be available for lending. This will result in an expansion of the money supply.Next
28. Try again!The money supply contracts when the reserve requirement is raised by the Fed.Back
29. Try again!When the Fed raises the reserve requirement the money supply contracts. The increase in the reserve requirement results in less money being available as excess reserves that can be in turn lent out by financial institutions.Back
30. Question 8The simple money multiplier is calculated as
31. Try again!This would lead to a greater increase of the money supply relative to a corresponding expansion of the monetary base. Banks may lend out only a fraction of all monies deposited. Back
32. Correct!The simple money multiplier is the reciprocal of the reserve requirement. The higher the reserve requirement the lower the simple money multiplier. The lower the reserve requirement the higher the simple money multiplier. When banks have to hold a larger fraction of deposits as required reserves the amount by which the money supply can expand relative to the monetary base is diminished.Next
33. Try again!This would result in a greater corresponding increase in the money supply.Back
34. Question 9The “Money Creation” formula is stated as
35. Try again!The simple money multiplier is calculated as 1 divided by the required reserve ratio.Back
36. Try again!Dividing excess reserves by the simple money multiplier will result in a number 100 times less than the correct application of the money creation formula has the potential to generate.Back
37. Correct!When there are no leakages to the money creation process multiplying excess reserves by the simple money multiplier will result in an expansion of the money supply greater than a corresponding increase in the monetary base.Next
38. Question 10Calculate the maximum money creation potential of a $1000 deposit when there is a 20% required reserve ratio.
39. Correct! The simple money multiplier for a 20% required reserve ratio is 5.(The reciprocal of the required reserve ratio.) When that 5 is multiplied by the $800 of excess reserves available for lending the result is $4,000 of money added to the initial $1,000 deposit for a total potential money creation of $5,000. Next
40. Try again!A 10% required reserve ratio would have the potential to turn a $1,000 deposit into $10,000 new money through a $9,000 expansion. Back
41. Try again!An expansion of a $1,000 deposit by $2,000 for a potential $3,000 of new money would indicate that the required reserve ratio is 50% resulting in a simple money multiplier of 2. Back
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