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What is Fiat Money?
Fiat money is the government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. The value of fiat money is derived from the relationship between supply and demand and the stability of the issuing government, rather than the worth of a commodity backing it as is the case for commodity money. Most modern paper currencies are fiat currencies, including the U.S. dollar, the euro and other major global currencies.
The word “fiat” comes from the Latin and is often translated as the decree “it shall be” or “let it be done.”
Terms and Answers to Learn
Which of the following best explains the difference between commodity money and fiat money?
A. Fiat money has no value except as money, whereas commodity money has value independent of its use as money
B. all money is commodity money, as it has to be exchanged for gold by the central bank
C. commodity money has no value except as money, where as fiat money has value independent of its use as money
A. Fiat money has no value except as money, whereas commodity money has value independent of its use as money
B. all money is commodity money, as it has to be exchanged for gold by the central bank
C. commodity money has no value except as money, where as fiat money has value independent of its use as money
A
Which one of the following is not a function of money?
A. open market operation
B. store of value
C. medium of exchange
D. unit of account
A. open market operation
B. store of value
C. medium of exchange
D. unit of account
A
If something is to be considered as money, it has to fulfill…
A. all three functions
B. all four functions
A. all three functions
B. all four functions
B
The use of money…
A. reduces the transaction costs of exchange
B. eliminates the double coincidence of wants
C. Allows for greater specialization
D. All of the above
A. reduces the transaction costs of exchange
B. eliminates the double coincidence of wants
C. Allows for greater specialization
D. All of the above
D
Money serves as a unit of account when
A. Sellers are willing to accept it in exchange for goods or services
B. It can be easily stored and used for transactions in the future
C. Prices of goods and services are stated in terms of money
A. Sellers are willing to accept it in exchange for goods or services
B. It can be easily stored and used for transactions in the future
C. Prices of goods and services are stated in terms of money
C
Money serves as a standard of deferred payment when
A. It can be easily store today and used for transactions in the future
B. Payments agreed to today but made in the future are in terms of money
C. Sellers are willing to accept it in exchange for goods or services
A. It can be easily store today and used for transactions in the future
B. Payments agreed to today but made in the future are in terms of money
C. Sellers are willing to accept it in exchange for goods or services
B
The Federal Reserve uses two definitions of the money supply, M1 and M2, because
A. M2 satisfies the medium of exchange function of money, whereas M1 satisfies the store of value function
B. M2 is a narrow definition focusing more on Liquidy, whereas M1 is a broader definition of the money supply
C. M1 is a narrow definition focusing more on liquidy, whereas M2 is a broader definition of the money supply
A. M2 satisfies the medium of exchange function of money, whereas M1 satisfies the store of value function
B. M2 is a narrow definition focusing more on Liquidy, whereas M1 is a broader definition of the money supply
C. M1 is a narrow definition focusing more on liquidy, whereas M2 is a broader definition of the money supply
C
Distinguishing among money, income, and wealth
A. A person’s money is the currency held and the checking account balance, income is the earning and wealth is equal to the value of assets minus all debts
B. A person’s money is the currency held and the earnings from work, income is equal to the bank balance and wealth is equal to the profit from investment
C. A person’s money is the currency in the pocket, income is the earning and wealth is equal to asset value
A. A person’s money is the currency held and the checking account balance, income is the earning and wealth is equal to the value of assets minus all debts
B. A person’s money is the currency held and the earnings from work, income is equal to the bank balance and wealth is equal to the profit from investment
C. A person’s money is the currency in the pocket, income is the earning and wealth is equal to asset value
A
The central bank of a country controls the money supply, which equals the currency held by
A. Banks
B. The public plus they’re checking and savings account balances
C. The public plus their checking account balances
A. Banks
B. The public plus they’re checking and savings account balances
C. The public plus their checking account balances
C
Suppose you have $2000 in currency in a shoebox in your closet. One day, you decide to deposit the money in a checking account. How will this action affect the M1 and M2 definitions of the money supply?
A. Both M1 and M2 will remain unchanged
B. M1 will decrease and M2 will increase
C. Both M1 and M2 will increase by $2000
A. Both M1 and M2 will remain unchanged
B. M1 will decrease and M2 will increase
C. Both M1 and M2 will increase by $2000
A
Credit cards are
A. Included in both the M1 and M2 definitions of the money supply
B.Included in the M1 definition of the money supply, but not in the M2 definition
C. Included in neither the M1 definition of the money supply nor in the M2 definition
A. Included in both the M1 and M2 definitions of the money supply
B.Included in the M1 definition of the money supply, but not in the M2 definition
C. Included in neither the M1 definition of the money supply nor in the M2 definition
C
What are the largest asset and the largest liability of a typical bank?
A. Loans of the largest assets and deposits are the largest liability of a typical bank
B. Reserves are the largest asset and deposits are the largest liability of a typical bank
C. Loans of the largest liability and deposits are the largest asset of a typical bank
A. Loans of the largest assets and deposits are the largest liability of a typical bank
B. Reserves are the largest asset and deposits are the largest liability of a typical bank
C. Loans of the largest liability and deposits are the largest asset of a typical bank
A
How do the banks create money?
A. When there is a decrease in checking account deposits, banks lose reserves and reduce their loans, and the money supply expands
B. When there is an increase in checking account deposits, banks gain reserves and make new loans, and the money supply expands
C. Banks buy bonds in the open market and gain reserves; this excess reserve holding increases the money supply
A. When there is a decrease in checking account deposits, banks lose reserves and reduce their loans, and the money supply expands
B. When there is an increase in checking account deposits, banks gain reserves and make new loans, and the money supply expands
C. Banks buy bonds in the open market and gain reserves; this excess reserve holding increases the money supply
B
The formula for the simple deposit multiplier is
A. 1/RR
B. -RR/1-RR
C. 1/1-RR
A. 1/RR
B. -RR/1-RR
C. 1/1-RR
A
The real world money multiplier
A. Equals the simple deposit multiplier because banks keep no excess reserves and households do not hold excess cash
B. Is smaller than the simple deposit multiplier because banks keep excess reserves and households hold excess cash
C. Is larger than the simple deposit multiplier because banks have no excess reserves and households do not deposit checks
A. Equals the simple deposit multiplier because banks keep no excess reserves and households do not hold excess cash
B. Is smaller than the simple deposit multiplier because banks keep excess reserves and households hold excess cash
C. Is larger than the simple deposit multiplier because banks have no excess reserves and households do not deposit checks
B
Assets are things of value that people own. Liabilities are debts. Therefore, a bank will always consider a checking account deposit to be an asset and a car loan to be a liability.
A. Disagree. Checking accounts represent something that the bank owes to the owner of the account. It is a bank liability
B. Agree. checking accounts or something of value that is in the bank. Therefore, they are a bank asset
C. Disagree. Both checking accounts and car loans represent bank liabilities
A. Disagree. Checking accounts represent something that the bank owes to the owner of the account. It is a bank liability
B. Agree. checking accounts or something of value that is in the bank. Therefore, they are a bank asset
C. Disagree. Both checking accounts and car loans represent bank liabilities
A
Excess reserves
A. Are loans made at above market interest rates
B. Are reserves banks keep above the legal requirement
C. Are reserves banks keep to meet the reserve requirement
A. Are loans made at above market interest rates
B. Are reserves banks keep above the legal requirement
C. Are reserves banks keep to meet the reserve requirement
B
Suppose American Bank has $500 in deposits and $200 in reserves and that the required reserve ratio is 10%. In this situation, American bank has
A. $50 in required reserves
B. $50 in excess reserves
C. $200 in required reserves
A. $50 in required reserves
B. $50 in excess reserves
C. $200 in required reserves
A
The simple deposit multiplier equals
A. the ratio of the amount of deposits created by banks to the amount of new reserves
B. The formula used to calculate the total increase in checking account deposits from an increase in bank reserves
C. The inverse, or reciprocal, of the required reserve ratio
D. All of the above
A. the ratio of the amount of deposits created by banks to the amount of new reserves
B. The formula used to calculate the total increase in checking account deposits from an increase in bank reserves
C. The inverse, or reciprocal, of the required reserve ratio
D. All of the above
D
A higher required reserve ratio _________ the value of the simple deposit multiplier
A. Increases
B. Decreases
C. Eliminates
A. Increases
B. Decreases
C. Eliminates
B
Congress passed legislation to create the federal reserve system in 1913 in order to
A. Take the monetary control over the economy away from the Treasury Department
B. End the instability created by a huge crude oil price hike during that time
C. End the instability created by bank panics by acting as a lender of last resort
A. Take the monetary control over the economy away from the Treasury Department
B. End the instability created by a huge crude oil price hike during that time
C. End the instability created by bank panics by acting as a lender of last resort
C
The most important role of the Federal Reserve in today’s US economy is
A. Negotiating with foreign nations to reduce the enormous trade deficit
B. Controlling the money supply to pursue economic objectives
C. Balancing the government’s budget by increasing taxes and cutting spending
A. Negotiating with foreign nations to reduce the enormous trade deficit
B. Controlling the money supply to pursue economic objectives
C. Balancing the government’s budget by increasing taxes and cutting spending
B
When the Federal Reserve purchases treasury securities in the open market,
A. The sellers of such securities by new securities in the open market and there is an increase in bank reserves
B. The sellers of such securities deposits the funds in their banks and bank reserves increase
C. The buyers of those securities pay for them with checks drawn on their bank account and bank reserves increase
A. The sellers of such securities by new securities in the open market and there is an increase in bank reserves
B. The sellers of such securities deposits the funds in their banks and bank reserves increase
C. The buyers of those securities pay for them with checks drawn on their bank account and bank reserves increase
B
When the Federal Reserve sells treasury securities in the open market,
A. The buyers of these securities pay for them with checks and bank reserves fall
B. The buyers of such securities by new securities in the open market and there is a decrease in bank reserves
C. The sellers of such securities deposit the funds in their banks and bank reserves decrease
A. The buyers of these securities pay for them with checks and bank reserves fall
B. The buyers of such securities by new securities in the open market and there is a decrease in bank reserves
C. The sellers of such securities deposit the funds in their banks and bank reserves decrease
A
Suppose that you are a bank manager, and the Federal Reserve raises the required reserve ratio from 10% to 12%. What actions would you need to take?
A. You would have to reduce lines to make up for the necessary increase in reserves
B. You would need to make loans to match the new reserve requirement
C. You would have to charge less for your loans because rates are now at 12%
A. You would have to reduce lines to make up for the necessary increase in reserves
B. You would need to make loans to match the new reserve requirement
C. You would have to charge less for your loans because rates are now at 12%
A
The United States is divided into ___ Federal Reserve districts
A. 14
B. 12
C. 8
A. 14
B. 12
C. 8
B
The federal reserve bank’s board of governors consists of __ members appointed by the president of the US to 14 year, nonrenewable terms
A. 8
B. 7
C. 6
A. 8
B. 7
C. 6
B
One of the board members is appointed to a __ year, renewable term as the chairman
A. 6
B. 4
C. 7
A. 6
B. 4
C. 7
B
Which of the following is a monetary policy tool used by the Federal Reserve Bank?
A. Decreasing the rate at which banks can borrow money from the Federal Reserve
B. Increasing the reserve requirement from 10% to 12.5%
C. Buying 500 million worth of government securities, such as treasury bills
D. All of the above
A. Decreasing the rate at which banks can borrow money from the Federal Reserve
B. Increasing the reserve requirement from 10% to 12.5%
C. Buying 500 million worth of government securities, such as treasury bills
D. All of the above
D
which of the following policy tools is the federal reserve the least likely to use in order to actively change the money supply?
A. Discount rate
B. Discount loans
C. Reserve requirements
A. Discount rate
B. Discount loans
C. Reserve requirements
C
Reserve requirements are changed infrequently because
A. Banks can determine the amount of reserves they wish to hold regardless of the reserve requirement
B. Banks cannot usually meet their reserve requirements so the Fed does not monitor it
C. Banks set long-term policy decisions, loan decisions, and deposit decisions based on the reserve requirement
A. Banks can determine the amount of reserves they wish to hold regardless of the reserve requirement
B. Banks cannot usually meet their reserve requirements so the Fed does not monitor it
C. Banks set long-term policy decisions, loan decisions, and deposit decisions based on the reserve requirement
C
By raising the discount rate, the Fed leads banks to make ______ loans to households and firms, which will _________ checking account deposits and the money supply
A. More; decrease
B. Fewer; decrease
C. Fewer; increase
A. More; decrease
B. Fewer; decrease
C. Fewer; increase
B
The quantity theory of money is better able to
A. To explain the inflation rate in the long run
B. To explain the full employment in the long run
C. To explain the inflation rate in the short run
A. To explain the inflation rate in the long run
B. To explain the full employment in the long run
C. To explain the inflation rate in the short run
A
The value of money varies
A. Inversely with the price level
B. Directly with the volume of employment
C. Directly with the price level
A. Inversely with the price level
B. Directly with the volume of employment
C. Directly with the price level
A
If the price index rises from 100 to 120, the purchasing power value of the dollar
A. May either rise or fall
B. Will rise by one sixth
C. Will fall by one sixth
A. May either rise or fall
B. Will rise by one sixth
C. Will fall by one sixth
C
Other things equal, an excessive increase in the money supply will
A. Increase the purchasing power of each dollar
B. Decrease the purchasing power of each dollar
C. Have no impact on the purchasing power of the dollar
A. Increase the purchasing power of each dollar
B. Decrease the purchasing power of each dollar
C. Have no impact on the purchasing power of the dollar
B
Suppose that the federal reserve increases bank reserves and banks lend out some of these reserves, but at some point banks still have 5 million more they wish to lend out. If the required reserve ratio is 10%, how much more money can banks create if they lend out the remaining amount?
A. 55 million
B. 50 million
C. 45 million
A. 55 million
B. 50 million
C. 45 million
B
Suppose the bank has a 10% reserve requirement, $5000 in deposits, and has loaned out all it can, given the reserve requirement
A. It has $500 in reserves and $4500 in loans
B. It has $50 in reserves and $4950 in loans
C. It has $555 in reserves and $4445 in loans
A. It has $500 in reserves and $4500 in loans
B. It has $50 in reserves and $4950 in loans
C. It has $555 in reserves and $4445 in loans
A
Suppose the banking system currently has 300 billion in reserves that the reserve requirement is 10%, and that $3 billion of the reserves are excess reserves that will not be lent out. What is the value of deposits?
A. $3300 billion
B. $2970 billion
C. $2673 billion
A. $3300 billion
B. $2970 billion
C. $2673 billion
B
Suppose that the federal reserve increases bank reserves and banks lend out some of these reserves, but at some point banks still have $5 million more they wish to lay down. If the required reserve ratio is 10%, how much more money can banks create if they lend out the remaining amount?
A. $55 million
B. $50 million
C. $45 million
A. $55 million
B. $50 million
C. $45 million
B
In a system of 100% reserve banking,
A. Banks do not accept deposits
B. Banks do not influence the supply of money
C. All of the above are correct
A. Banks do not accept deposits
B. Banks do not influence the supply of money
C. All of the above are correct
B
A bank which must hold 100% reserves opens in an economy that had no banks and a currency of $100. If customers deposit $50 into the bank, what is the value of the money supply?
A. $50
B. $100
C. $150
A. $50
B. $100
C. $150
B
When the Federal Reserve conducts open market operations to increase the money supply, it
A. Redeems federal reserve notes
B. Buys government bonds from the public
C. Raises the discount rate
A. Redeems federal reserve notes
B. Buys government bonds from the public
C. Raises the discount rate
B
When the Fed conducts open market purchases,
A. Banks by treasury securities from Fed, which increases the money supply
B. Banks by treasury securities from the Fed, which decreases the money supply
C. It buys treasury securities, which increases the money supply
A. Banks by treasury securities from Fed, which increases the money supply
B. Banks by treasury securities from the Fed, which decreases the money supply
C. It buys treasury securities, which increases the money supply
C
When the Fed decreases the discount rate, banks will
A. Borrow more from the Fed and lend more to the public. The money supply increases
B. Borrow more from the Fed and lend less to the public. The money supply decreases
C. Borrow less from the Fed and lend more to the public. The money supply increases
A. Borrow more from the Fed and lend more to the public. The money supply increases
B. Borrow more from the Fed and lend less to the public. The money supply decreases
C. Borrow less from the Fed and lend more to the public. The money supply increases
A
To decrease the money supply, the Fed can
A. Buy government bonds or increase the discount rate
B. Buy government bonds or decrease the discount rate
C. Sell government bonds or increase the discount rate
A. Buy government bonds or increase the discount rate
B. Buy government bonds or decrease the discount rate
C. Sell government bonds or increase the discount rate
C
in 1991, the Federal Reserve lowered the reserve requirement from 12% to 10%. Other things the same this should have
A. Increased both the money multiplier and the money supply
B. Decreased both the money multiplier and the money supply
C. Increased the money multiplier and decrease the money supply
A. Increased both the money multiplier and the money supply
B. Decreased both the money multiplier and the money supply
C. Increased the money multiplier and decrease the money supply
A
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