Free Master of Economics: Money, Banks, and Interest Rates Questions and Answers

Question 1

Which of the subsequent would result in a bank losing reserves?

Accepted Answer

One of the bank's depositors pays out a cheque to a depositor of another bank.

Answer

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?

Accepted Answer

Unless the authorities intervened, there is no limit to how much money banks would be willing to create.

Answer

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?

1. The bank deposit multiplier is 25.
2. The money multiplier is 17.

Accepted Answer

Both 1 and 2.

Answer

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?

Accepted Answer

A fall in the interest rate.

Answer

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?

Accepted Answer

A fall in the interest rate will shift IS to the right.

Answer

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.

MEcon Master of Economics Practice Test

MEcon Master of Economics Practice Test

Free Master of Economics: Money, Banks, and Interest Rates Questions and Answers