Transcript
224Miller•Economics Today, Nineteenth Edition
Chapter 15Money, Banking, and Central Banking223
Answers to Questions for Critical Analysis
Is Money Really Just for “Record Keeping”? (p. 324)
Which function of money is most closely related to the “record-keeping” idea? Explain your reasoning.
Record keeping relies on a standard of value, so that money functions as a unit of accounting.
What Does Zimbabwe Now Use as Money, and Why? (pp. 326?327)
Why do you suppose that people first stopped regularly using Zimbabwean dollars as a store of value before deciding to halt their use as a medium of exchange?
As a result of high and variable inflation in Zimbabwe, the value of Zimbabwean dollars was not at all predictable.
Customers Pay Fees to Hold Hundreds of Billions in Deposits at Banks (p. 330)
If interest rates earned by banks on all of their assets fell close to zero, why might all bank customers have to pay interest fees on deposits they hold with banks?
Banks earn interest returns from assets or loans that banks generate from customers’ deposits. As the interest rates earned by banks on their assets fell close to zero, banks were less willing to hold deposits as before.
Why Bother with a Debit Card When Payments Can Accompany “Tweets”? (p. 332)
Why does a credit-card transaction to buy an item fail to count as part of the M1 measure of money? (Hint: When you make a credit-card payment, the bank that issued you the credit card instantaneously extends a loan to you for the amount of the transaction.)
A credit-card transaction involves a loan from the bank that issues the credit card. Hence, a transaction with a credit card does not immediately involve a payment with cash or any other component of M1.
You Are There
In Europe, Some Borrowers Receive Bank Interest Payments on Their Loans (p. 342)
1. How do you suppose that the willingness of European banks to make adjustable-rate mortgage loans has been affected by the decrease in interest rates that they earn?
A decrease in interest rates that European bank earn would reduce their willingness to make adjustable-rate mortgage loans.
2. Why do you suppose that European banks that are issuing new adjustable-rate mortgage loans now add a larger intermediation charge to the Euribor to determine the loan rate?
The Euribor is the rate at which European banks must pay if they decide to borrow funds from other banks. As the Euribor becomes negative, banks are less willing to extend mortgage loans with negative interest rates. In response to the negative Euribor rate, Banks might add a larger intermediation charge to new mortgage loans.
Issues & Applications
Why U.S. Taxpayers Are Last-Resort Funders of Much of the Financial Industry (pp. 343–344)
1. Even though the federal government requires depository institutions to contribute premiums to the FDIC, who ultimately has to provide sufficient funds if the FDIC runs out of cash? (Hint: The FDIC borrowed funds from the U.S. Treasury in 1991 and 2009.)
Taxpayers ultimately have to provide the funds if the FDIC runs out of cash.
2. Now that FNMA and FHLMC are again privately financed and operated institutions, will the government’s guarantees to them remain explicit or become implicit once again?
The government’s guarantees of those private institutions will become implicit guarantees.
Research Project
1. Read the text of the Dodd-Frank Wall Street Reform and Consumer Protection Act at the Web Links in MyEconLab.
2. Take a look at the Federal Reserve Bank of Richmond’s Bailout Barometer at the Web Links in MyEconLab.
Answers to Problems
15-1. Until 1946, residents of the island of Yap used large doughnut-shaped stones as financial assets. Although prices of goods and services were not quoted in terms of the stones, the stones were often used in exchange for particularly large purchases, such as livestock. To make the transaction, several individuals would insert a large stick through a stone’s center and carry it to its new owner. A stone was difficult for any one person to steal, so an owner typically would lean it against the side of his or her home as a sign to others of accumulated purchasing power that would hold value for later use in exchange. Loans would often be repaid using the stones. In what ways did these stones function as money?
Medium of exchange; store of value; standard of deferred payment
15-2. During the late 1970s, prices quoted in terms of the Israeli currency, the shekel, rose so fast that grocery stores listed their prices in terms of the U.S. dollar and provided customers with dollar-shekel conversion tables that they updated daily. Although people continued
to buy goods and services and make loans using shekels, many Israeli citizens converted shekels to dollars to avoid a reduction in their wealth due to inflation. In what way did the U.S. dollar function as money in Israel during this period?
Unit of accounting; store of value
15-3. During the 1945–1946 Hungarian hyperinflation, when the rate of inflation reached 41.9 quadrillion percent per month, the Hungarian government discovered that the real value of its tax receipts was falling dramatically. To keep real tax revenues more stable, it created
a good called a “tax pengö,” in which all bank deposits were denominated for purposes of taxation. Nevertheless, payments for goods and services were made only in terms of the regular Hungarian currency, whose value tended to fall rapidly even though the value of
a tax pengö remained stable. Prices were also quoted only in terms of the regular currency. Lenders, however, began denominating loan payments in terms of tax pengös. In what ways did the tax pengö function as money in Hungary in 1945 and 1946?
store of value; standard of deferred payment
15-4. Considering the following data (expressed in billions of U.S. dollars), calculate Ml and M2.
Currency 1,050
Savings deposits 5,500
Small-denomination time deposits 1,000
Traveler’s checks outside banks and thrifts 10
Total money market mutual funds 800
Institution-only money market mutual funds 1,800
Transactions deposits 1,140
M1 equals transactions deposits plus currency plus traveler’s checks, or $1,140 billion + $1,050 billion + $10 billion = $2,200 billion; M2 equals M1 + savings deposits plus small-denomination time deposits plus retail (non-institution) money market mutual funds, or $2,200 billion + $5,500 billion + $1,000 billion + $800 billion = $9,500 billion.
15-5. Considering the following data (expressed in billions of U.S. dollars), calculate Ml and M2. (See pages 340–341.)
Transactions deposits 1,025
Savings deposits 3,300
Small-denomination time deposits 1,450
Money market deposit accounts 1,950
Noninstitution money market mutual funds 1,900
Traveler’s checks outside banks and thrifts 25
Currency 1,050
Institution-only money market mutual funds 1,250
M1 equals transactions deposits plus currency plus traveler’s checks, or $1,025 billion + $1,050 billion + $25 billion = $2,100 billion; M2 equals M1 + savings deposits plus small-denomination time deposits plus money market deposit accounts plus retail (noninstitution) money market mutual funds, or $2,100 billion + $3,300 billion + $1,450 billion + $1,950 billion + $1,900 billion = $10,700 billion.
15-6. Identify whether each of the following amounts is counted in Ml only, M2 only, both Ml and M2, or neither.
a. $50 billion in U.S. Treasury bills
b. $15 billion in small-denomination time deposits
c. $5 billion in traveler’s checks not issued by a bank
d. $20 billion in money market deposit accounts
a. neither
b. M2 only
c. M1 and M2
d. M2 only
15-7. Identify whether each of the following items is counted in Ml only, M2 only, both Ml and M2, or neither.
a. A $1,000 balance in a transactions deposit at a mutual savings bank
b. A $100,000 time deposit in a New York bank
c. A $10,000 time deposit an elderly widow holds at her credit union
d. A $50 traveler’s check not issued by a bank
e. A $50,000 savings deposit
a. M1 and M2
b. neither
c. M2 only
d. M1 and M2
e. M2 only
15-8. Match each of the rationales for financial intermediation listed below with at least one of the following financial intermediaries: insurance company, pension fund, savings bank. Explain your choices.
a. Adverse selection
b. Moral hazard
c. Lower management costs generated by larger scale
In principle, each institution can match with each rationale; your explanations are the most important aspects of your answers.
a. Insurance companies limit adverse selection by screening applicants for policies.
b. Savings banks limit moral hazard by monitoring borrowers after loans have been made.
c. Pension funds reduce management costs by pooling the funds of many future pensioners.
15-9. Identify whether each of the following events poses an adverse selection problem or a moral hazard problem in financial markets.
a. A manager of a savings and loan association responds to reports of a likely increase in federal deposit insurance coverage. She directs loan officers to extend mortgage loans to less creditworthy borrowers.
b. A loan applicant does not mention that a legal judgment in his divorce case will require him to make alimony payments to his ex-wife.
c. An individual who was recently approved for a loan to start a new business decides to use some of the funds to take a Hawaiian vacation.
a. moral hazard problem
b. adverse selection problem
c. moral hazard problem
15-10. In what sense is currency a liability of the Federal Reserve System?
In an extreme case in which the U.S. government was to close down the Federal Reserve System,
it would have to compensate holders of Federal Reserve currency for the face value of those notes.
15-11. In what respects is the Fed like a private banking institution? In what respects is it more like a government agency?
The Fed provides banking services such as check clearing services and large-value payment services for other banks and for the U.S. Treasury, just as a private bank provides such services for its customers. Unlike a private bank, however, the Federal Reserve serves as a lender of last resort, a regulator, and a policymaker.
15-12. Take a look at the map of the locations of the Federal Reserve districts and their headquarters in Figure 15-6. Today, the U.S. population is centered just west of the Mississippi River—that is, about half of the population is either to the west or the east of a line running roughly just west of this river. Can you reconcile the current locations of Fed districts and banks with this fact? Why do you suppose the Fed has its current geographic structure?
Back in 1913, the population was centered farther to the east. Thus, congressional representation was centered farther to the east, so political concerns together with a view that the Fed districts should be designed to best serve the existing population helped determine the geographic boundaries. These have not been redrawn since.
15-13. Draw an empty bank balance sheet, with the heading “Assets” on the left and the heading “Liabilities” on the right. Then place the following items on the proper side of the balance sheet:
a. Loans to a private company
b. Borrowings from a Federal Reserve district bank
c. Deposits with a Federal Reserve district bank
d. U.S. Treasury bills
e. Vault cash
f. Transactions deposits
a. asset
b. liability
c. asset
d. asset
e. asset
f. liability
15-14. Draw an empty bank balance sheet, with the heading “Assets” on the left and the heading “Liabilities” on the right. Then place the following items on the proper side of the balance sheet.
a. Borrowings from another bank in the interbank loans market
b. Deposits this bank holds in an account with another private bank
c. U.S. Treasury bonds
d. Small-denomination time deposits
e. Mortgage loans to household customers
f. Money market deposit accounts
a. liability
b. asset
c. asset
d. liability
e. asset
f. liability
15-15. The reserve ratio is 11 percent. What is the value of the potential money multiplier?
The maximum potential money multiplier is 1 / 0.11 = 9.09
15-16. The Federal Reserve purchases $1 million in U.S. Treasury bonds from a bond dealer, and the dealer’s bank credits the dealer’s account. The reserve ratio is 15 percent. Assuming that no currency leakage occurs, how much will the bank lend to its customers following the Fed’s purchase?
The dealer’s bank will hold 15 percent of the $1 million, or $150,000, as reserves. Thus, the bank will lend out $850,000.
15-17. Suppose that the value of the potential money multiplier is equal to 4. What is the reserve ratio?
25 percent (or 0.25)
15-18. Consider a world in which there is no currency and depository institutions issue only transactions deposits. The reserve ratio is 20 percent. The central bank sells $1 billion
in government securities. What ultimately happens to the money supply?
The money supply declines by $5 billion.
15-19. Assume a 1 percent reserve ratio and no currency leakages. What is the potential money multiplier? How will total deposits in the banking system ultimately change if the Federal Reserve purchases $5 million in U.S. government securities?
The maximum potential money multiplier is 1/0.01 = 100, so total deposits in the banking system will increase by $5 million 100 = $500 million.
15-20. Consider Figure 15-1, which focuses on liquidity. How might limited acceptability of old masters paintings in exchange and difficulties in predicting the values of these paintings from year to year help to explain their relatively low liquidity? How might these characteristics affect the likelihood that these assets could function as forms of money?
While some who like paintings might accept old masters paintings in exchange, others who do not would be less willing, hence their relatively low levels of liquidity and limited usefulness as a medium of exchange. Difficulties in predicting the paintings’ value would make the paintings uncertain stores of purchasing power and thereby also reduce their liquidity and usefulness as forms of money.
15-21. Does Figure 15-3 depict direct finance or indirect finance? Explain. How could the figure be revised to illustrate the alternative form of finance?
The figure depicts indirect finance, a process through which ultimate lenders channel funds to ultimate borrowers indirectly through financial intermediaries such as those listed in the middle stage of the figure. Direct finance could be depicted by eliminated that middle stage—that is, by leaving financial intermediaries out of the process.
15-22. Consider Figure 15-4. Explain how Jill Jones’s debit-card transaction affects the assets and liabilities of Citibank and of Bank of America. Why does this transaction leave unchanged the total quantity of deposits in the banking system and, consequently, the money supply?
The $200 transfer out of Jill Jones’s Bank of America deposit account causes Bank of America’s liabilities to decline by $200, which requires the bank’s assets to decrease by the same amount. Simultaneously, the transfer into Macy’s deposit account with Citibank causes Citibank’s liabilities and assets to rise by $200. Total deposits change by +$200 ?$200 = $0, so total deposits and the money supply are unaffected.
15-23. Take a look at Figure 15-5. Suppose that the Federal Reserve’s focus of monetary policymaking shifted away from buying and selling U.S. government securities to utilizing the discount rate or the interest rate paid on bank reserves as the Fed’s main policy instrument. If so, would the Federal Open Market Committee necessarily remain the Fed’s key policymaking group?
The seven members of the Fed’s Board of Governors have ultimate responsibility for setting the interest rate paid on bank reserves. Thus, a shift toward utilizing interest on reserves as the key instrument of monetary policy would shift policymaking authority away from the Federal Open Market Committee to the Board of Governors.
15-24. Consider Figure 15-7. Describe the basic shape that this figure would take if the Fed had instead generated a multiple contraction in the money supply by removing $100,000 in reserves from the banking system via an open market sale?
An open market sale of $100,000 that removed reserves from the banking system would cause every number in the figure to have a negative value of the same absolute amount currently displayed. As a result, a figure depicting the resulting multiple contraction of the money supply would be a vertical mirror image of the existing figure, with all amounts appearing below the horizontal axis.
15-25. In Problem 15-24, what would be the amount of the potential money multiplier that applies to a $100,000 decrease in reserves caused by a Fed open market sale of that amount? How much would the money supply potentially decrease as a result of this sale?
The potential money multiplier would still equal 1 / reserve ratio = 1/0.10 = 10. Consequently,
the potential decrease in the money supply would be ?$100,000 multiplied by 10, or ?$1,000,000.
Selected References
Angell, N., The Story of Money, London: Stokes, 1929.
Campbell, Colin and Rosemary Campbell, An Introduction to Money and Banking, 4th ed., Hinsdale, IL: Dryden Press, 1984.
Friedman, Milton and Anna Schwartz, A Monetary History of the United States 1867–1960, Princeton, NJ: Princeton University Press, 1963.
Miller, Roger L. and David D. VanHoose, Modern Money and Banking, 3rd ed., New York:
McGraw-Hill, 1993.
Ritter, L.S. and W.L. Silber, Principles of Money, Banking, and Financial Markets, 9th ed., New York: Basic Books, 1997.
Smith, Warren L., “Monetary Institutions and Policies,” in Perspectives in Economics, Alan A. Brown, Egon Neuberger, and Malcolm Palmatier, eds., New York: McGraw-Hill, 1971.
