Unit 8: Money, Banking, and the Federal Reserve
What money actually is, how one deposit multiplies through the banking system, and how the Fed steers interest rates in today's ample-reserves world.
10 topics · 37 questions
Each topic is a path, not a menu: work down it in order and every question builds on the one above. Click any of them to watch the answer draw itself.
What Money Is and What It Does
- How it worksHow do money's three jobs, as a medium of exchange, a unit of account, and a store of value, solve the problem of needing a double coincidence of wants?
- Common mistakeWhy isn't money the same thing as wealth or the same thing as income?
- Going furtherWhat happens to money's job as a store of value once a country falls into a hyperinflation?
Your turn1 of 2
A person owns a house worth 400,000 dollars but has only 200 dollars in cash and checking accounts. Is this person's entire 400,000 dollars of house value counted as 'money' in the economic sense?Measuring the Money Supply: M1 and M2
- How it worksWalk me through what goes into M1 and what gets added on top of it to reach M2.
- Worked exampleFind M1 and M2 from 1500 dollars in currency, 3200 dollars in checkable deposits, and 9000 dollars in savings deposits.
- Common mistakeWhy isn't a credit card's spending limit counted as part of the money supply?
- Going furtherWhat happens to M1 and M2 the moment someone moves 800 dollars out of savings and into a checking account?
Your turn1 of 2
Find M1, in dollars, from 2045 dollars in currency and 3947 dollars in checkable deposits.The Bank Balance Sheet and T-Accounts
- How it worksWalk me through a bank's T-account listing reserves and loans as assets against deposits as a liability.
- Worked exampleFind a bank's required reserves and excess reserves when it holds 8000 dollars in deposits at a 10 percent required reserve ratio.
- Common mistakeWhy doesn't a bank run mean the bank was doing something dishonest with its depositors' money?
- Going furtherWhat happens to a bank's T-account the moment it takes 4000 dollars of its excess reserves and lends them out?
Your turn1 of 2
Find a bank's required reserves when it holds 11964 dollars in deposits at a 13 percent required reserve ratio.Deposit Expansion Round by Round
- How it worksWalk me through round one, round two, and round three of lending and redepositing as a single dollar moves bank to bank.
- Worked exampleFind how much new money exists after just the first three rounds of lending from a 1000 dollar deposit at a 20 percent reserve ratio.
- Common mistakeWhy doesn't the banking system create this new money out of thin air with absolutely no limit?
- Going furtherWhat happens to each round of lending once a borrower decides to hold part of the loan as cash instead of redepositing it?
Your turn1 of 2
Find how much new money exists after just the first three rounds of lending from a 1287 dollar deposit at a 20 percent reserve ratio.Deriving the Money Multiplier
- How it worksHow does summing an infinite geometric series of ever-smaller lending rounds produce the formula 1 divided by the reserve ratio?
- Worked exampleFind the money multiplier and the maximum money creation from a 3000 dollar deposit at a 15 percent required reserve ratio.
- Common mistakeWhy isn't the money multiplier a fixed law of nature rather than a ceiling built on assumptions?
- Going furtherWhat happens to the size of the multiplier when the required reserve ratio is cut from 10 percent to 5 percent?
- Ties togetherHow does a system with a binding reserve requirement, where this multiplier applies, differ from the ample-reserves system covered next?
Your turn1 of 2
Find the maximum money creation from a 3786 dollar deposit at a 16 percent required reserve ratio.Why the Multiplier Overstates Real-World Expansion
- How it worksHow do excess reserves banks choose to hold and cash the public keeps out of banks leak out of every lending round?
- Worked exampleFind money creation from a 2000 dollar deposit when banks hold 5 percent in extra reserves on top of a 10 percent requirement.
- Common mistakeWhy isn't every dollar of new reserves in the banking system guaranteed to turn into new loans?
- Going furtherWhat happens to the money supply when banks, worried about defaults, decide to sit on their excess reserves instead of lending them?
Your turn1 of 2
Find money creation from a 3089 dollar deposit when banks hold 8 percent in extra reserves on top of a 13 percent requirement.The Federal Reserve's Structure and Dual Mandate
- How it worksHow is the Federal Reserve organized across a Board of Governors, twelve regional banks, and the rate-setting FOMC?
- Common mistakeWhy isn't the Federal Reserve simply a branch of the United States Treasury?
- Going furtherWhat happens to policy debates when the Fed's two mandated goals, stable prices and maximum employment, point in opposite directions?
Your turn1 of 2
A student assumes the Federal Reserve is simply a branch of the United States Treasury Department, since both deal with the nation's money. Is this an accurate description of the Fed's structure?Traditional Monetary Policy Tools
- How it worksWalk me through an open market purchase adding reserves to the banking system and lowering the federal funds rate.
- Common mistakeWhy isn't it true that the Federal Reserve prints the money supply directly and hands it out?
- Going furtherWhat changes about the policy toolkit when the Fed adjusts the discount rate or the reserve requirement instead?
Your turn1 of 2
An open market purchase of 224 million dollars in bonds, with a required reserve ratio of 16 percent, could expand the money supply by up to how much through the money multiplier?Ample Reserves and Interest on Reserve Balances
- How it worksHow does interest on reserve balances set a floor that stops banks from lending reserves to each other for less?
- Common mistakeWhy isn't the old story, that the Fed changes the money supply to move the interest rate, how policy works once reserves are ample?
- Going furtherWhat would the reserve market graph look like instead if reserves became scarce rather than ample?
- Worked exampleFind where the federal funds rate settles when the interest rate on reserve balances is 4.5 percent and reserves are ample.
Your turn1 of 2
Find where the federal funds rate settles when the interest rate on reserve balances is 5 percent and reserves are ample.Monetary Policy and Bank Regulation Working Together
- How it worksHow do capital requirements and deposit insurance work alongside interest rate policy to keep the banking system stable?
- Going furtherWhat happens to monetary policy's effectiveness when a wave of bank failures freezes up lending during a downturn?
- Common mistakeWhy isn't deposit insurance the same thing as a guarantee that a bank itself cannot fail?
Your turn1 of 2
A bank holds 1545 million dollars in assets and is required to hold capital equal to 10 percent of assets. How much capital must it hold?