Fractional Reserve System

Respond to the questions/prompts that follow in order to prepare for the exam.

  • To calculate the amount of reserves that a commercial bank is required to hold, simply do the following:
  • What does the term “fractional” in “fractional reserve system” mean with regard to the nature of the modern banking system and the supply of money?
  • Vault cash, property, and stock shares are all _____________ to a commercial bank.
  • Why does the demand for money increase with an increase in nominal GDP?
  • Explain how granting a bank loan creates money and repaying a bank loan eliminates money in the real sector.
  • What is the cost associated with holding money?
  • Do banks create money when they buy government bonds from or when they sell bonds to households?
  • What is the market in which banks borrow reserves from one another on an overnight basis?
  • How does a bank calculate its excess reserves?
  • What happens to the total demand for money when interest rates increase? What happens to the total demand for money when interest rates decrease?
  • What is the Fed trying to do when it increases the Fed Funds rate? What about when the rate is decreased?
  • Explain how changing the reserve ratio can be used to both expand and reduce the supply of money. How often is the reserve ratio changed?
  • Is the Fed likely buy or sell bonds in the event of excess inflation?
  • Which tool of monetary policy does the Fed often use to manipulate the reserves held by commercial banks?
  • In the United States, what entity conducts monetary policy?
  • Which unit within the Fed conducts open-market operations?
  • Using the terms “employment” and “inflation,” write one sentence describing the general goal of the Fed.
  • What are the three functions of money?
  • Paper currency and modern coinage are “token money.” What does this mean?
  • What was TARP and what was the aim of the Fed in creating the program?
  • How do credit and debit cards differ?
  • Why are bank panics very rare (virtually non-existent) in the recent history of the US?
  • Procedurally, how does one become a member of the Fed’s Board of Governors?
  • What “backs” the money supply in the US?

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