Free Master of Economics: Money, Banks, and Interest Rates Questions and Answers — Questions and Answers
Question 1: Which of the subsequent would result in a bank losing reserves?
- One of the bank's depositors pays out a cheque to a depositor of another bank. (Correct answer)
- The bank raises the interest rate it pays on deposits.
- One of the bank's depositors makes an internet payment to another of its depositors.
- One of the bank's depositors pays out a cheque to another of its depositors.
Correct answer: One of the bank's depositors pays out a cheque to a depositor of another bank.
When a depositor writes a cheque to someone who banks at a different institution, the funds must be transferred from the first bank's reserves to the second bank's reserves. This interbank transfer directly reduces the reserves held by the paying bank, as its liability (the deposit) decreases and its asset (reserves) also decreases.
Question 2: Which of the following claims regarding bank money generation is untrue?
- A bank creates money when it buys securities.
- Unless the authorities intervened, there is no limit to how much money banks would be willing to create. (Correct answer)
- The increase in deposits that can occur when banks get £1 million extra reserves is greater than £1 million.
- A bank creates money when it writes a higher number against the deposit of a depositor who wants an advance.
Correct answer: Unless the authorities intervened, there is no limit to how much money banks would be willing to create.
The claim that banks have no limit to money creation without intervention is untrue because banks are inherently constrained by factors like their reserves, capital requirements, and the public's demand for cash versus deposits. Even without direct central bank intervention, these market and regulatory forces naturally limit the extent of money generation. The central bank's control over the monetary base and reserve ratios further reinforces these limits.
Question 3: Assume banks want a 4% ratio of reserves to deposits. And let's assume that the general public wants a 2% cash-to-deposit ratio. Which of the following statements is true? <br> <br> 1. The bank deposit multiplier is 25. <br> 2. The money multiplier is 17.
- 1 only.
- 2 only.
- Both 1 and 2. (Correct answer)
- Neither 1 nor 2.
Correct answer: Both 1 and 2.
Given a reserve-to-deposit ratio (rr) of 4% (0.04) and a cash-to-deposit ratio (c) of 2% (0.02), both statements are true. The bank deposit multiplier is calculated as 1/rr, which is 1/0.04 = 25. The money multiplier, which accounts for cash held by the public, is calculated as (1+c)/(rr+c), which is (1+0.02)/(0.04+0.02) = 1.02/0.06 = 17. Both calculations align with the standard formulas in monetary economics.
Question 4: Which of the following would not cause a rightward change in the money demand curve?
- A rise in wealth.
- A rise in incomes.
- A fall in the interest rate. (Correct answer)
- A move which means that all workers who were in the past paid weekly will in future be paid monthly.
Correct answer: A fall in the interest rate.
A fall in the interest rate causes a movement *along* the money demand curve, not a shift of the curve itself. When interest rates fall, the opportunity cost of holding money decreases, leading people to demand more money balances for transactions and precautionary motives. Factors like a rise in wealth, incomes, or changes in payment frequency (like being paid monthly instead of weekly) would increase the overall demand for money at any given interest rate, thus shifting the entire money demand curve to the right.
Question 5: Which of the aforementioned claims regarding the IS curve is untrue?
- An increase in exports will shift IS to the right.
- A fall in the interest rate will shift IS to the right. (Correct answer)
- It shows that the lower is the interest rate, the higher is the equilibrium level of output.
- The more responsive planned spending is to changes in the interest rate, the more interest elastic is the IS curve.
Correct answer: A fall in the interest rate will shift IS to the right.
The claim that a fall in the interest rate will shift the IS curve to the right is untrue. The IS curve illustrates the inverse relationship between the interest rate and the equilibrium level of output in the goods market. A fall in the interest rate causes a *movement along* the existing IS curve, leading to a higher equilibrium output due to increased investment and consumption. Shifts of the IS curve are caused by changes in autonomous spending (e.g., government spending, investment, exports) or taxes, which alter aggregate demand at any given interest rate.
Question 6: Which of the LM curve's following claims is untrue?
- It shows that the higher is the level of output, the higher is the equilibrium rate of interest.
- The more interest elastic is the demand for money, the more interest elastic is the LM curve.
- An increase in the supply of money curve will shift LM right.
- An increase in the demand for money will shift LM right. (Correct answer)
Correct answer: An increase in the demand for money will shift LM right.
The claim that an increase in the demand for money will shift the LM curve right is untrue. The LM curve represents equilibrium in the money market. An increase in the demand for money, for a given money supply, means that a higher interest rate is required to clear the money market at any given level of output. This causes the LM curve to shift *left (up)*, reflecting that for any output level, a higher interest rate is needed to reduce money demand back to the fixed supply.
Question 7: Suppose the multiplier is four and the first increase in projected investment is £100 billion annually. Which of the subsequent claims is untrue?
- The IS curve will shift to the right by less than £400 billion a year. (Correct answer)
- By ignoring the fact that a rise in output will lead to higher interest rates, the multiplier model will predict that the planned expenditure line will end up £100 billion a year higher than it started.
- By ignoring the fact that a rise in output will lead to higher interest rates, the multiplier model will predict a rise in output of £400 billion a year.
- By allowing for the fact that a rise in output will lead to higher interest rates, the IS-LM model will predict a rise in output of less than £400 billion a year.
Correct answer: The IS curve will shift to the right by less than £400 billion a year.
The claim that the IS curve will shift to the right by less than £400 billion a year is untrue. The IS curve shifts by the initial change in autonomous spending multiplied by the simple expenditure multiplier. With an initial increase in planned investment of £100 billion and a multiplier of four, the IS curve will shift to the right by exactly £400 billion (£100 billion * 4). The IS-LM model then predicts that the *actual* rise in output will be less than £400 billion due to the accompanying rise in interest rates, which dampens investment, but this is a movement along the LM curve, not a change in the IS curve's shift amount.
Free Master of Economics: Money, Banks, and Interest Rates Questions and Answers
Which of the subsequent would result in a bank losing reserves?