AP Macro Banking System 3 — Questions and Answers
Question 1: If the reserve requirement is reduced from 20% to 10%, what happens to the money multiplier?
- It decreases from 5 to 10
- It increases from 5 to 10 (Correct answer)
- It stays the same
- It decreases from 10 to 5
Correct answer: It increases from 5 to 10
The money multiplier equals 1/reserve requirement; reducing RR from 20% to 10% raises the multiplier from 5 to 10.
Question 2: In a fractional reserve banking system, banks:
- Hold 100% of deposits as reserves
- Hold only a fraction of deposits as reserves and lend the rest (Correct answer)
- Lend out all deposits received
- Are prohibited from making loans
Correct answer: Hold only a fraction of deposits as reserves and lend the rest
Fractional reserve banking means banks keep only a fraction of deposits as reserves while lending the remainder.
Question 3: When the Fed conducts contractionary monetary policy, which of the following is most likely?
- The money supply increases and interest rates fall
- The money supply decreases and interest rates rise (Correct answer)
- GDP automatically rises
- Banks receive more reserves
Correct answer: The money supply decreases and interest rates rise
Contractionary policy reduces the money supply by removing reserves, which pushes interest rates higher.
Question 4: The federal funds rate is:
- The rate the Fed charges for loans to banks
- The rate banks charge their best customers
- The overnight rate banks charge each other for reserve loans (Correct answer)
- The rate on 10-year Treasury bonds
Correct answer: The overnight rate banks charge each other for reserve loans
The federal funds rate is the interest rate at which banks lend reserves to each other overnight.
Question 5: Which of the following is a tool of the Federal Reserve used to conduct monetary policy?
- Setting income tax rates
- Changing the minimum wage
- Open market operations (Correct answer)
- Issuing new currency to the public directly
Correct answer: Open market operations
Open market operations — buying or selling government securities — are the Fed's primary tool for controlling the money supply.
Question 6: If banks decide to hold more excess reserves than usual, the actual money multiplier will be:
- Greater than the theoretical multiplier
- Equal to the theoretical multiplier
- Less than the theoretical multiplier (Correct answer)
- Zero
Correct answer: Less than the theoretical multiplier
When banks hold excess reserves rather than lending them out, money creation is reduced, making the actual multiplier smaller.
Question 7: A bank's balance sheet shows assets of $500,000 and liabilities of $450,000. The bank's net worth (equity) is:
- $950,000
- $500,000
- $450,000
- $50,000 (Correct answer)
Correct answer: $50,000
Net worth equals assets minus liabilities: $500,000 − $450,000 = $50,000.
AP Macro Banking System 3
If the reserve requirement is reduced from 20% to 10%, what happens to the money multiplier?