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Chapter 15: Q. 18 (page 347)

Consider a world in which there is no currency and depository institutions issue only transactions deposits. The reserve ratio is 20 percent. The central bank sells1 billion in government securities. What ultimately happens to the money supply?

Short Answer

Expert verified

The money supply should function as usual with the added benefits of banks maintaining a twenty percent reserve ratio.

Step by step solution

01

Transaction deposit.

A deposit is a transaction in which something is transferred to another party for safekeeping. In the financial sector, a deposit is a sum of money that is stored or placed in a bank account in order to earn interest.

02

Reason for the money supply.

The money supply should continue to function normally, with the extra benefit of banks retaining a 20%reserve ratio.

Some economists believe that abolishing deposit insurance will benefit the government in the long run because deposits are risk-free currency claims, implying that we operate with 100%reserves. If banks were required to maintain a minimum of 25%equity, the risk would be transferred back to the banks rather than the government or shareholders.

As a result, banks will invest in lower-risk possibilities and the money supply will grow if the reserve ratio is maintained.

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Most popular questions from this chapter

How do you suppose that the willingness of European banks to make adjustable-fate mortgase loans has been affected by the desrease in interest rates that they eam?

Considering the following data (expressed in billions of U.S. dollars), calculate M1 and M2.

Identify whether each of the following events poses an adverse selection problem or a moral hazard problem in financial markets.

a. A manager of a savings and loan association responds to reports of a likely increase in federal deposit insurance coverage. She directs loan officers to extend mortgage loans to less creditworthy borrowers.

b. A loan applicant does not mention that a legal judgment in his divorce case will require him to make alimony payments to his ex-wife.

c. An individual who was recently approved for a loan to start a new business decides to use some of the funds to take a Hawaiian vacation.

Consider Figure 15-4. Explain how Jill Jones's debit-card transaction affects the assets and liabilities of Citibank and of Bank of America. Why does this transaction leave unchanged the total quantity of deposits in the banking system and, consequently, the money supply?

Take a look at Figure 15-5. Suppose that the Federal Reserve's focus on monetary policymaking shifted away from buying and selling U.S.government securities to utilizing the discount rate or the interest rate paid on bank reserves as the Fed's main policy instrument. If so, would the Federal Open Market Committee necessarily remain the Fed's key policymaking group?
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