Answers to Homework #6 Essay
1. What distinguishes money from other assets in the economy?
Money is the most liquid asset.
2. What is commodity money? What is fiat money? Which kind do we use?
Commodity money may be used for other purposes. Fiat money is useful only as money. 3. What are demand deposits? Why should they be included in the stock of money?
Demand deposits are balances in bank accounts that can be accessed on demand by writing a check. They are money, since they are generally accepted as a medium of exchange. 4. Which of the following are money in the U.S. economy? Which are not? Explain your answers by discussing each in terms of the three functions of …show more content…
d. By how much can the entire banking system expand their loans?
10 x 150 = $1500
e. What conditions are necessary for this maximum expansion of deposits to occur?
Banks lend all ER, and all loaned funds are returned to the banking system.
f. Where did the funds for this maximum expansion come from?
Nowhere. This expansion of deposits is newly-created money by bank lending. g. How much new wealth is directly created from this expansion of deposits?
Zero: there is an offsetting liability created by each loan.
6. A commercial bank has deposits of $100,000 and total reserves of $31,000. The required reserve ratio is 15%. All other banks are fully loaned up.
a. Show this bank’s balance sheet.
Reserves 31,000 Deposits 100,000
b. Calculate actual reserves (AR), required reserves (RR), and excess reserves (ER).
AR = 31,000
RR = 15,000
ER = 16,000
c. What is the largest loan this bank can make? $16,000
d. If the bank loans out all of its excess reserves, what is the maximum expansion of the money supply that can occur if other banks also lend as much as possible?
(1/.15) x 16,000 = 106,66
e. Where did this additional money come from? Newly created from bank lending
What “backs” this money? Faith that loans will be repaid
7. Explain how each of the following policy actions by the Fed would affect AR, RR, ER, bank lending, and the growth of the money supply: