Econ QB QB - Ch20 (ENG)

Economics Inquiry for HKDSE Macroeconomics 1 Chapter 20 Money Supply and Money Demand
Multiple Choice Questions QUESTION 01 Which of the following is/are included in money supply? (1) coins in public circulation (2) banknotes in public circulation (3) bank deposits
A. B. C. D.
(2) only (3) only (1) and (2) only (1), (2) and (3)
## D Money supply includes cash (banknotes and coins) in public circulation and bank deposits. ##
QUESTION 02 Money supply M1 includes _______________. (1) demand deposits with licensed banks (2) savings deposits with licensed banks (3) currency held by the public
A. B. C. D.
(1) and (2) only (1) and (3) only (2) and (3) only (1), (2) and (3)
## B M1 = Currency held by the public + Demand deposits with licensed banks Savings deposits with licensed banks are included in M2 and M3 but not M1. ##
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QUESTION 03 Banknotes held by banks _______________ in money supply M1, because _______________. A. B. C. D. is included their value is rather stable is included the liquidity of these banknotes is very high is not included these banknotes are not used as a medium of exchange is not included they cannot fulfil the function of money as a store of value
## C M1 = Currency held by the public + Demand deposits with licensed banks M1 emphasises the function of money as the medium of exchange. Banknotes held by banks are not used as a medium of exchange. ##
QUESTION 04 In Hong Kong, _______________ is the narrowest definition of money supply. A. B. C. D. money supply M1 money supply M2 money supply M3 None of the above.
## A M1 = Currency held by the public + Demand deposits with licensed banks M2 = M1 + Savings deposits and time deposits with licensed banks + Negotiable certificates of deposit issued by licensed banks held outside the banking sector M3 = M2 + Deposits with restricted licence banks and deposit-taking companies + Negotiable certificates of deposit issued by restricted licence banks and deposit-taking companies held outside the banking sector M1 is the narrowest definition of money supply in Hong Kong, as both M2 and M3 consist of the components of M1. ##
20-2
QUESTION 05 Which of the following about money supply M1 is CORRECT? A. B. C. D. Time deposits are included in M1. M1 is the broadest definition of money supply. Negotiable certificates of deposit are included in M1. M1 consists of non-interest-bearing components only.
## D M1 = Currency held by the public + Demand deposits with licensed banks Both the currency held by the public and demand deposits with licensed banks do not bear interest. Option A is incorrect. Time deposits with licensed banks are included in both M2 and M3. Time deposits with restricted licence banks and deposit-taking companies are included in M3. Option B is incorrect. M1 is the narrowest definition of money supply. Option C is incorrect. Negotiable certificates of deposit issued by licensed banks held outside the banking sector are included in both M2 and M3. Negotiable certificates of deposit issued by restricted licence banks and deposit-taking companies held outside the banking sector are included in M3. ##
QUESTION 06 Money supply M2 emphasises the function of money as a _______________. A. B. C. D. medium of exchange store of value unit of account standard of deferred payment
## B M2 includes those components in M1, savings deposits and time deposits with licensed banks and negotiable certificates of deposit (NCDs) issued by licensed banks held outside the banking sector. These deposits and NCDs cannot settle payments immediately. They can function as a store of value but not a medium of exchange. ##
20-3
QUESTION 07 Which of the following are included in money supply M2? (1) currency held by the public (2) demand deposits with licensed banks (3) time deposits with licensed banks (4) time deposits with deposit-taking companies
A. B. C. D.
(1) and (2) only (3) and (4) only (1), (2) and (3) only (2), (3) and (4) only
## C M2 = M1 (Currency held by the public + Demand deposits with licensed banks) + Saving deposits and time deposits with licensed banks + Negotiable certificates of deposit issued by licensed banks held outside the banking sector Currency held by the public, demand deposits and time deposits with licensed banks are included in M2. Time deposits with deposit-taking companies are included in M3 only. ##
QUESTION 08 Which of the following statements about money supply M2 is/are INCORRECT? (1) Money supply M2 has broader coverage than money supply M1. (2) Money supply M2 includes all the components of money supply M3. (3) Negotiable certificates of deposit issued by deposit-taking companies are included in money supply M2. (4) Demand deposits are included in money supply M2.
A. B. C. D.
(2) only (1) and (4) only (2) and (3) only (2), (3) and (4) only
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## C (2) is incorrect. M3 has a broader coverage than M2. (3) is incorrect. Negotiable certificates of deposit issued by deposit-taking companies are included in M3, but not in M2. ##
QUESTION 09 Negotiable certificates of deposit issued by _______________ are included in money supply M3. (1) licensed banks (2) restricted licence banks (3) deposit-taking companies
A. B. C. D.
## D M3 = M2 + Deposits with restricted licence banks and deposit-taking companies + Negotiable certificates of deposit issued by restricted licence banks and deposit-taking companies held outside the banking sector Since the negotiable certificates of deposit issued by licensed banks are included in M2, they are also included in M3. Therefore, negotiable certificates of deposit issued by licensed banks, restricted licence banks and deposit-taking companies are included in M3. ##
20-5
QUESTION 10 Study the following table.
Currency held by the public Demand deposits Deposits with licensed banks Deposits with restricted licence banks and deposit-taking companies Negotiable certificates of deposit issued by licensed banks, restricted licence banks and deposit-taking companies
$ billion 2 5 12 20 18
The money supply M2 of this economy is A. B. C. D. $7 billion. $19 billion. $57 billion. indeterminate.
## D M2 = M1 (Currency held by the public + Demand deposits with licensed banks) + Saving deposits and time deposits with licensed banks + Negotiable certificates of deposit issued by licensed banks held outside the banking sector As we cannot get the figure of negotiable certificates of deposit issued only by licensed banks, we cannot determine the figure of M2. ##
20-6
QUESTION 11 Peter transfers $30,000 from his time deposit account in a licensed bank to his current account in the same bank. What will be the immediate effect on money supply M1 and M2 of Hong Kong? A. B. C. D. Both money supply M1 and M2 decrease. Both money supply M1 and M2 increase. Money supply M1 remains unchanged while money supply M2 decreases. Money supply M1 increases while money supply M2 remains unchanged.
## D Peter withdraws $30,000 from his time deposit account in a licensed bank He transfers $30,000 to his current account in the same bank Net change M1 increases while M2 remains unchanged. ## M1 +$30,000 ----+$30,000 0 M2
QUESTION 12 Mrs. Lee withdraws a $5,000 deposit from a deposit-taking company and keeps it as cash. What will be the immediate effect on money supply M1 and M3 of Hong Kong? A. B. C. D. Both money supply M1 and M3 increases. Both money supply M1 and M3 decrease. Money supply M1 increases while money supply M3 remains unchanged. Money supply M1 remains unchanged while money supply M3 decreases.
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## C M1 = Currency held by the public + Demand deposits with licensed banks As currency held by the public increases by $5,000 while the amount of demand deposits with licensed banks remains unchanged, M1 increases by $5,000. Deposits with a deposit-taking company are included in M3. When Mrs. Lee withdraws a $5,000 deposit from a deposit-taking company, M3 decreases by $5,000. Since M1 increases by $5,000, M3 remains unchanged. ##
QUESTION 13 Which of the following events will lead to a change in money supply M1? A. B. Jenny deposits a certain amount of cash into her current account. Lily uses the cash in hand to buy a negotiable certificate of deposit issued by a licensed bank. C. D. Mary buys a car by cheque and the seller deposits the amount into his current account. Danny withdraws a certain amount of money from his time deposit account with a licensed bank and uses it to buy a negotiable certificate of deposit issued by a deposit-taking company.
## B M1 = Currency held by the public + Demand deposits with licensed banks When Lily uses the cash in hand to buy a negotiable certificate of deposit issued by a licensed bank, currency held by the public will decrease while demand deposits with licensed banks will remain unchanged. Therefore, M1 will decrease. ##
20-8
QUESTION 14 Suppose people prefer holding more assets in the form of negotiable certificates of deposit and fewer assets in the form of cash. This MUST lead to a fall in money supply A. B. C. D. M1. M2. M2 and M3. M1, M2 and M3.
## A M1 = Currency held by the public + Demand deposits with licensed banks Since currency held by the public decreases while demand deposits with licensed banks remain unchanged, M1 must decrease. As we do not know whether the negotiable certificates of deposit are issued by licensed banks, restricted licence banks or deposit-taking companies, M2 may not decrease. M3 includes M1 and the negotiable certificates of deposit are issued by licensed banks, restricted licence banks and deposit-taking companies. Therefore, the effect caused by holding more negotiable certificates of deposit on M3 is offset by holding less cash. M3 remains unchanged. ##
QUESTION 15 Suppose Mr. Wong withdraws $80,000 from his time deposit account in a licensed bank. He remits $50,000 to his mother in the US and deposits the remaining money into a restricted licence bank. As a result, money supply M1 _______________, M2 _______________ and M3 _______________. A. B. C. D. remains unchanged decreases decreases remains unchanged decreases increases decreases decreases decreases increases remains unchanged remains unchanged
20-9
## A Mr. Wong withdraws $80,000 from his time deposit account in a licensed bank He remits $50,000 to his mother in the US He deposits the remaining $30,000 into a restricted licence bank Net change M1 +$80,000 -$50,000 -$30,000 0 M2 ----$50,000 -$30,000 -$80,000 M3 ----$50,000 ----$50,000
M1 remains unchanged while M2 and M3 decrease. ##
QUESTION 16 _______________ consist(s) of both interest-bearing components and non-interest-bearing components. (1) M1 (2) M2 (3) M3
A. B. C. D.
(1) only (3) only (1) and (2) only (2) and (3) only
## D (1) is incorrect. M1 consists of non-interest-bearing components only. ##
20-10
QUESTION 17 Jane remits $4,000 cash in hand to Japan. What is the immediate effect of Janes action on the money supply of Hong Kong? A. B. C. D. Money supply M1, M2 and M3 remain unchanged. Money supply M1, M2 and M3 decrease. Money supply M1 and M2 decrease while money supply M3 remains unchanged. Money supply M1 decreases while money supply M2 and M3 remain unchanged.
## B The $4,000 remittance is no longer included in the money supply of Hong Kong. Therefore, M1, M2 and M3 decrease by $4,000. ##
QUESTION 18 Suppose Bank XYZ has $500,000 of deposit and the minimum reserve ratio is 10%. The actual reserves held by Bank XYZ are $80,000. The actual reserve ratio is _______________ and the amount of excess reserves is _______________. A. B. C. D. 10% $30,000 10% $80,000 16% $30,000 16% $80,000
## C Actual reserve ratio = Actual reserves / Total deposits = $80,000 / $500,000 = 16% Excess reserves = Actual reserves Required reserves = $80,000 $50,000 = $30,000 ##
20-11
QUESTION 19 If there are excess reserves in the banking system, which of the following is/are CORRECT? (1) The actual reserves in the banking system are larger than the required reserves. (2) The actual reserve ratio is larger than the required reserve ratio. (3) The actual banking multiplier is greater than the maximum banking multiplier.
A. B. C. D.
(1) only (3) only (1) and (2) only (1), (2) and (3)
## C (1) is correct. Excess reserves = Actual reserves Required reserves As there are excess reserves, the actual reserves in the banking system are larger than the required reserves. (2) is correct. Actual reserve ratio = Actual reserves / Total deposits Required reserve ratio = Required reserves / Total deposits As the actual reserves are larger than the required reserves, the actual reserve ratio is thus larger than the required reserve ratio. (3) is incorrect. Actual banking multiplier = 1 / actual reserve ratio, while maximum banking multiplier = 1 / required reserve ratio. As the actual reserve ratio is larger than the required reserve ratio, the actual banking multiplier is smaller than the maximum banking multiplier. ##
QUESTION 20 Suppose the total deposits in Bank ABC are $100,000. The actual reserves are $30,000 and there are excess reserves of $5,000. The maximum banking multiplier is _______________. A. B. C. D. 5 20 3.33 4
20-12
## D Required reserves = Actual reserves Excess reserves = $30,000 $5,000 = $25,000 Required reserve ratio = Required reserves / Total deposits = $25,000 / $100,000 = 25% Maximum banking multiplier = 1 / Required reserve ratio = 1 / 25% = 4 ##
QUESTION 21 Ben withdraws $3,000 from his current account in Bank ABC and deposits this sum of money into his savings account in Bank XYZ. If the required reserve ratio is 15%, the maximum possible amount of deposits will increase by A. B. C. D. $0. $3,000. $20,000. There is insufficient information to determine the answer.
## A Money creation resulting from the increase in deposits in Bank XYZ will be offset by money contraction brought by the withdrawal of deposits in Bank ABC by the same amount. The maximum possible amount of deposits will not increase. ##
20-13
QUESTION 22 The following table shows the balance sheet of a banking system. No banks hold excess reserves.
Assets ($) Reserves Loans 250 750 Deposits
Liabilities ($) 1,000
Suppose a customer withdraws $100 from a bank. The immediate effect(s) on the banking system is/are (1) a shortage of reserve of $100. (2) a decrease in reserves by $100. (3) a decrease in deposits by $400.
A. B. C. D.
(2) only (1) and (2) only (2) and (3) only (1), (2) and (3)
## A After the withdrawal, the balance sheet is as below: Assets ($) Reserves Loans 150 750 Deposits Liabilities ($) 900
(2) is correct. The amount of reserves decreases from $250 to $150. (1) is incorrect. As there are no excess reserves in the banking system, required reserve ratio = $250 / $1,000 = 25%. When the amount of deposits is $900, required reserves = $900 25% = $225 There is a shortage of reserves of $75 ($225 $150). (3) is incorrect. The amount of deposits decreases by $100 ($1,000 $900). ##
20-14
QUESTION 23 The following table shows the balance sheet of a banking system.
Assume the legal reserve ratio is 15%. Which of the following statements is INCORRECT? A. B. C. D. The required reserves are $180. The actual banking multiplier is 6.67. There are excess reserves of $120. The actual reserve ratio is 25%.
## B Actual reserve ratio = Actual reserves / Total deposits = $300 / $1,200 = 25% Actual banking multiplier = 1 / Actual reserve ratio = 1 / 25% = 4 Option A is correct. Required reserves = Total deposits Required reserve ratio = $1,200 15% = $180 Option C is correct. Excess reserves = Actual reserves Required reserve = $300 $180 = $120 ##
20-15
QUESTION 24 The following table shows the balance sheet of a banking system. The banking system is fully loaned up. There is a currency deposit ratio of 10%.
Assets ($) Reserves Loans 1,000 4,000 Deposits
(a) The money supply of this economy is A. B. C. D. $5,000. $5,500. $6,000. $27,500.
(b) Suppose $600 of banknotes are issued by the government. The maximum amount of deposits in the banking system is A. B. C. D. $5,600. $7,000. $7,700. $8,000.
## (a) B Money supply = Cash in public circulation + Bank deposits = $5,000 10% + $5,000 = $5,500
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(b) B As the banking system is fully loaned up, required reserve ratio = $1,000 / $5,000 = 20%. The maximum amount of new deposits = Amount of bank notes issued / (Required reserve ratio + Currency deposit ratio) = $600 / (20% + 10%) = $2,000 Therefore, the maximum amount of deposits in the banking system = $5,000 + $2,000 = $7,000 ##
QUESTION 25 Assume the required reserve ratio is 25%. If Bank ABC has deposits of $200,000 and its actual reserves are three times of its required reserves, the excess reserves are _______________. A. B. C. D. $0 $50,000 $100,000 $150,000
## C Required reserves = Total deposits Required reserve ratio = $200,000 25% = $50,000 Actual reserves = $50,000 3 = $150,000 Excess reserves = Actual reserves Required reserves = $150,000 $50,000 = $100,000 ##
20-17
QUESTION 26 The following table shows the balance sheet of Bank ABC.
Assets ($) Reserves Loans and investments 600 1,400 Deposits
If the excess reserves are $150, which of the following is CORRECT? A. B. C. D. The required reserves are $400. The actual reserve ratio is smaller than the required reserve ratio. The maximum banking multiplier is 4.44. The actual reserve ratio is 33%.
## C Required reserve ratio = (Actual reserves Excess reserves) / Total deposits = ($600 $150) / $2,000 = 22.5% Maximum banking multiplier = 1 / Required reserve ratio = 1 / 22.5% = 4.44 Option A is incorrect. Required reserves = Actual reserves Excess reserves = $600 $150 = $450. Option B and D are incorrect. Actual reserve ratio = Actual reserves / Total deposits = $600 / $2,000 = 30%. ##
20-18
QUESTION 27 The following table shows the balance sheet of a banking system. There are excess reserves of $100.
The minimum reserve ratio is _______________ and the actual reserve ratio is _______________. A. B. C. D. 6.7% 13.33% 6.7% 20% 13.33% 20% 20% 13.33%
## C Minimum reserve ratio = (Actual reserves Excess reserves) / Total deposits = ($300 $100) / $1,500 = 13.33% Actual reserve ratio = Actual reserves / Total deposits = $300 / $1,500 = 20% ##
QUESTION 28 Suppose the required reserve ratio of a banking system is 10%. If someone deposits $200 into the banking system, what is the maximum increase in deposits in the banking system if there is a cash leakage of 10% of newly created loans in the deposit creation process? A. B. C. D. $800 $1,000 $2,000 There is insufficient information to answer.
## B Maximum increase in deposits in the banking system = $200 / (10% + 10%) = $1,000 ##
20-19
QUESTION 29 The following table shows the balance sheet of a bank. The minimum reserve ratio of the banking system is 20%.
If the bank lends out all the excess reserves, the amount of deposits after credit creation process is _______________. A. B. C. D. $1,800 $1,900 $2,160 $2,250
## D The amount of deposits after credit creation process = $450 (1 / 0.2) = $2,250 ##
QUESTION 30 Suppose someone deposits $500 cash into his savings account but the bank cannot make any new loans. Money supply will _______________. A. B. C. D. increase decrease remain unchanged increase or decrease
20-20
## C Money supply = Cash in public circulation + Bank deposits Cash in public circulation falls by $500. As the bank cannot make any new loans from this sum of money, this sum of money becomes the excess reserves of the bank. Bank deposits increases by $500. Money supply will thus remain unchanged. ##
QUESTION 31 If the required reserve ratio of a banking system is 100%, which of the following statements is INCORRECT? A. B. The excess reserves are always zero. When someone deposits $10,000 cash into his or her current account, the money supply remains unchanged. C. D. The maximum banking multiplier is 1. The monetary base of the economy is smaller than the money supply.
## D Money supply = Cash in public circulation + Bank deposits Monetary base = Currency in public circulation + Bank reserves If the required reserve ratio is 100%, the maximum banking multiplier is 1. Bank deposits are equal to bank reserves. The monetary base of the economy is equal to the money supply. Option A is correct. All bank reserves are required reserves, so there will be no excess reserves in the banking system. Option B is correct. When someone deposits $10,000 into his or her current account, cash in public circulation decreases by $10,000 while bank deposits increase by $10,000. The money supply remains unchanged. Option C is correct. Maximum banking multiplier = 1 / Required reserve ratio = 1 / 100% = 1 ##
20-21
Suppose there are excess reserves of $500. Which of the following statements is CORRECT? A. B. C. D. The actual banking multiplier is 10. The required reserve ratio is 35%. The maximum possible amount of deposits created is $7,000. The actual reserve ratio is 10%.
## C Required reserve ratio = ($700 $500) / $2,000 = 10% Maximum possible amount of deposits created = $700 / 10% = $7,000 ##
QUESTION 33 The following table shows the balance sheet of a banking system. The required reserve ratio is 25%.
Assets ($) Cash reserves Loans
Liabilities ($) 800 2,200 Deposits 3,000
Suppose the banks lend out all excess reserves. The maximum possible amount of deposits and loans are _______________ and _______________ respectively. A. B. C. D. $50 $2,200 $200 $2,800 $2,400 $3,200 $3,200 $2,400
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## D Maximum possible amount of deposits = $800 (1 / 25%) = $3,200 Maximum possible amount of loans = [$800 (1 25%)] / (1 / 25%) = $2,400 ##
QUESTION 34 Money supply will increase if A. B. C. D. banks decide to hold more reserves. the central bank raises the minimum reserve ratio. more new coins are issued by the central bank. All of the above.
## C Money supply = Cash in public circulation + Bank deposits If more coins are issued by the central bank, cash in public circulation will increase. Money supply will increase. Option A is incorrect. If banks decide to hold more reserves, the maximum amount of deposits created in the banking system will decrease. Money supply will decrease. Option B is incorrect. When the central bank raises the minimum reserve ratio, reserves that banks can loan out will decrease. Bank deposits will decrease and money supply will decrease. ##
20-23
QUESTION 35 In reality, the actual amount of deposits created in a banking system is always less than the maximum possible amount created. Which of the following is/are the main reason(s)? (1) Banks cannot lend out all their excess reserves. (2) Banks keep reserves at a level higher than that required by the government for safety reasons. (3) The public keeps some of the loans as cash to deal with daily transactions.
A. B. C. D.
## D Both (1) and (2) are correct. If banks cannot lend out all their excess reserves or they keep reserves at a level higher than that required by the government for safety reasons, banks have excess reserves. The actual amount of deposits created will be smaller than the maximum possible amount. (3) is correct. If the public keeps some of the loans as cash to deal with daily transactions, the amount of deposits created will become smaller. ##
QUESTION 36 Which of the following is/are the necessary condition(s) for deposit creation to take place? (1) There is no cash leakage. (2) The required reserve ratio is less than 100%. (3) Banks do not have excess reserves. (4) There is demand for loans.
A. B. C. D.
(4) only (1) and (3) only (2) and (4) only (1), (2) and (4) only
20-24
## C (2) is correct. If the required reserve ratio is 100%, banks will not have excess reserves to lend out. New money cannot be created. (4) is correct. If there is no demand for loans, no one will borrow from banks. Banks can only keep deposits as reserves. The banking system cannot create any new money. (1) and (3) are incorrect. If there is cash leakage or banks have excess reserves, the banking system cannot create the maximum possible amount of money; some new money can still be created though. ##
QUESTION 37 Miss Leung received $10,000 from her father in England and she deposited this money into a bank in Hong Kong. If the required reserve ratio is 20%, the maximum increase in Hong Kongs money supply is A. B. C. D. $10,000. $40,000. $50,000. $60,000.
## C Money supply = Cash in public circulation + Bank deposits Maximum increase in money supply = $0 (no change in cash in public circulation) + $10,000 (1 / 20%) (maximum possible amount of deposits created) = $50,000 ##
20-25
QUESTION 38 Without deposit creation, when a local resident deposits some cash into a bank, the amount of _______________ increases while the amount of _______________ remains unchanged. A. B. C. D. bank deposits money supply bank deposits bank reserves monetary base deposits money supply deposits
## A Money supply = Cash in public circulation + Bank deposits Without deposit creation, the decrease in cash in public circulation is equal to the increase in bank deposits. Money supply remains unchanged. Option B is incorrect. Bank reserves will increase by the amount of deposits. Option C is incorrect. Monetary base = Currency in public circulation + Bank reserves Without deposit creation, the decrease in currency in public circulation is equal to the increase in bank reserves. Monetary base remains unchanged. ##
QUESTION 39 In a banking system, total deposits reach the maximum possible amount by credit creation. Which of the following must be CORRECT? (1) The actual banking multiplier is equal to the maximum banking multiplier. (2) The reserve deposit ratio is equal to the required reserve ratio. (3) The money supply is equal to the monetary base.
A. B. C. D.
20-26
## A Actual banking multiplier = 1 / Actual reserve ratio Maximum banking multiplier = 1 / Required reserve ratio If total deposits reach the maximum possible amount, the actual reserves will be equal to the required reserves. The actual reserve ratio (i.e. the reserve deposit ratio) will be equal to the required reserve ratio. The actual banking multiplier will also be equal to the maximum banking multiplier. (3) is incorrect. Money supply = cash in public circulation + bank deposits, while monetary base = currency in public circulation + bank reserves. Total deposits reaching the maximum possible amount does not imply that the bank deposits and the bank reserves are equal. ##
QUESTION 40 Suppose all the banks in an economy are fully loaned up. If the required reserve ratio in the banking system is smaller than 100%, which of the following is/are CORRECT? (1) The maximum banking multiplier is greater than 1. (2) The money multiplier is greater than 1. (3) The currency deposit ratio is smaller than 1.
A. B. C. D.
(1) only (1) and (2) only (1) and (3) only (2) and (3) only
20-27
## B (1) is correct. Maximum banking multiplier = 1 / Required reserve ratio As the required reserve ratio is smaller than 100%, the maximum banking multiplier is greater than 1. (2) is correct. Money multiplier = Money supply / Monetary base As the required reserve ratio is smaller than 100%, the process of credit creation allows the money supply of an economy to be greater than its monetary base. (3) is incorrect. Currency deposit ratio is the ratio between currency and deposits which the public chooses to hold. It is not determined by the level of the required reserve ratio. ##
QUESTION 41 When the _______________ increases, the maximum banking multiplier will decrease. A. B. C. D. total amount of deposits currency held by public demand for loans minimum reserve ratio
## D Maximum banking multiplier = 1 / Minimum reserve ratio When the minimum reserve ratio increases, the maximum banking multiplier will decrease. ##
QUESTION 42 Which of the following statements about monetary base is INCORRECT? A. B. C. D. Monetary base is also called high-powered money. Monetary base is always smaller than money supply. Monetary base decreases if someone remits money to a foreign country. Monetary base is the total amount of currency issued by the central bank.
20-28
## B Monetary base = Currency in public circulation + Bank reserves Money supply = Cash in public circulation + Bank deposits If the required reserve ratio is 100%, bank reserves will be equal to bank deposits and monetary base will be equal to money supply. ##
QUESTION 43 When the nominal interest rate decreases, _______________ for money increases and people will hold _______________ money. A. B. C. D. transaction demand more transaction demand less asset demand more asset demand less
## C When the nominal interest rate decreases, asset demand for money increases while transaction demand for money is not affected. The nominal interest rate is the opportunity cost of holding money. When the nominal interest rate decreases, the opportunity cost of holding money decreases and people will hold more money. ##
QUESTION 44 Which of the following statements about high-powered money (M0) is/are CORRECT? (1) It is the sum of currency in public circulation and reserves in the banking system. (2) It must be smaller than M1. (3) It is the total amount of currency issued by the central bank.
A. B. C. D.
(1) only (1) and (2) only (1) and (3) only (2) and (3) only
20-29
## C (2) is incorrect. M0 = Currency in public circulation + Bank reserves M1 = Currency held by the public + Demand deposits with licensed banks There is no direct relationship between M0 and M1. M0 can be smaller than, equal to or greater than M1. ##
QUESTION 45 If more people use Octopus Cards to deal with daily transactions, A. B. C. D. the money supply curve will shift to the right. the money demand curve will shift to the left. the nominal interest rate will increase. None of the above.
## B When more people use Octopus Cards to deal with daily transactions, people will reduce the amount of cash held for transactions. This would reduce the transaction demand for money as well as the total demand for money. The money demand curve will shift to the left. Option A is incorrect. The money supply will not be affected. Option C is incorrect. Given the money supply curve, when the money demand curve shifts to the left, the nominal interest rate will decrease. ##
20-30
QUESTION 46 Which of the following about money demand is/are CORRECT? (1) The money demand curve shows the relationship between the quantity of money demanded and the nominal interest rate, assuming all other factors affecting the amount of money that people wish to hold remain the same. (2) The money demand curve is upward-sloping. (3) Any change in the nominal interest rate will lead to a movement along the money demand curve.
A. B. C. D.
(3) only (1) and (2) only (1) and (3) only None of the above.
## C (2) is incorrect. As demand for money is negatively related to the nominal interest rate, the money demand curve is downward-sloping. ##
QUESTION 47 When nominal income increases, _______________ will increase; when the nominal interest rate increases, _______________ will decrease. A. B. C. D. total demand for money total demand for money total demand for money total quantity demanded for money total quantity demanded for money total demand for money total quantity demanded for money total quantity demanded for money
20-31
## B When there is an increase in nominal income, people will consume more goods and services. As there are more transactions to be made, total demand for money will increase. When the nominal interest rate increases, asset demand for money decreases while transaction demand for money is not affected. Thus, the total quantity demanded for money will decrease. ##
QUESTION 48 Suppose the demand for money decreases. If the central bank wants to stabilise the nominal interest rate, it can _______________ the required reserve ratio so as to _______________ money supply. A. B. C. D. raise increase raise decrease lower increase lower decrease
## C If the demand for money decreases, there will be a leftward shift of the money demand curve. The nominal interest rate will decrease. To stabilise the nominal interest rate, the central bank has to reduce money supply. When the central bank raises the required reserve ratio, given the same amount of reserves held, the commercial banks will not have enough required reserves for their deposits. In order to satisfy the higher reserve ratio, they need to reduce their lending or even call back loans from the public. Through deposit contraction, money supply will decrease. ##
20-32
QUESTION 49 When the nominal interest rate of a country increases, _______________ will decrease. (1) the level of planned investment (2) the level of national income (3) the value of domestic currency in terms of foreign currency
A. B. C. D.
## A (1) is correct. When the nominal interest rate of a country increases, the level of planned investment will decrease as the interest rate is the opportunity cost of funds used to finance investment. (2) is correct. When the nominal interest rate of a country increases, investment expenditure, consumption expenditure and net exports will decrease. National income will therefore fall. (3) is incorrect. When the nominal interest rate of a country increases, holding the interest rates in other countries constant, foreign investment will flow into the country in order to earn a higher interest rate, causing the countrys currency to appreciate (the value of domestic currency in terms of foreign currency to increase). ##
QUESTION 50 If people expect bond prices to increase, _______________ will _______________. A. B. C. D. transaction demand for money increase transaction demand for money decrease asset demand for money increase asset demand for money decrease
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## D When people expect bond prices to increase, they will choose to hold more bonds and less money as assets. Asset demand for money will therefore decrease. ##
QUESTION 51 When money demand decreases, the equilibrium interest rate will _______________ and the consumption expenditure will _______________. A. B. C. D. decrease decrease decrease increase increase increase increase decrease
## B When money demand decreases, the money demand curve shifts leftwards. The equilibrium interest rate will decrease. This will lead to an increase in the consumption expenditure. ##
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QUESTION 52 Study the table below.
Asset demand for money ($) 200 300 400 500 600
Transaction demand for money ($) 700 700 700 700 700
Money supply ($) 1,200 1,200 1,200 1,200 1,200
Nominal interest rate (%) 15 13 11 9 7
What is the equilibrium interest rate? A. B. C. D. 7% 9% 11% 13%
## B Total demand for money ($) 200 + 700 = 900 300 + 700 = 1,000 400 + 700 = 1,100 500 + 700 = 1,200 600 + 700 = 1,300 Money supply ($) 1,200 1,200 1,200 1,200 1,200 Nominal interest rate (%) 15 13 11 9 7
When the total demand for money is equal to the money supply ($1,200), the nominal interest rate is at equilibrium which is 9%. ##
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QUESTION 53 Assume the interest rate of Country A increases while the interest rates of other countries remain constant. There will be an _______________ Country A, and the exchange rates of Country As currency to other currencies will _______________. A. B. C. D. inflow of capital to increase inflow of capital to decrease outflow of capital from increase outflow of capital from decrease
## A When the interest rate of Country A increases while the interest rates in other countries remain constant, foreign investment will flow into Country A in order to earn a higher interest rate, causing the countrys currency to appreciate, i.e. the exchange rates of Country As currency to other currencies will increase. ##
QUESTION 54 Which of the following will cause the demand for money in Country Y to increase? (1) a fall in nominal interest rate (2) a rise in the nominal income of people (3) an expectation of a fall in nominal interest rate
A. B. C. D.
(2) only (1) and (2) only (2) and (3) only (1), (2) and (3)
## A (1) is incorrect. A change in the nominal interest rate will lead to a movement along the money demand curve, but not a shift of the money demand curve. ##
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QUESTION 55 (NEW) Which of the following events would cause the money supply M1 to remain unchanged but the money supply M3 to increase? A. B. C. D. Miss Chow withdraws $2,000 from her demand deposits and keeps it as cash. Miss Yu transfers $2,000 from her demand deposits to savings deposits with a licensed bank. Miss Lee receives $2,000 cash from overseas and deposits it in a restricted licence bank. Miss So uses $2,000 cash in hand to buy a negotiable certificate of deposit issued by a licensed bank.
## C M1 = Currency held by the public + Demand deposits with licensed banks M3 = M2 + Deposits with restricted licence banks and deposit-taking companies + Negotiable certificates of deposit issued by restricted licence banks and deposit-taking companies held outside the banking sector Since the $2,000 cash received from overseas is deposited in a restricted licence bank, M3 will increase while M1 will remain unchanged. ##
QUESTION 56 (NEW) Which of the following is an effect of lowering the legal reserve requirement for banks? A. B. C. D. The deposit creating ability of the banking system will increase. The use of credit cards will become more popular. The cash held by the public will decrease. The demand for loans will increase.
## A Lowering the legal reserve requirement for banks implies a lower minimum reserve ratio. This will increase the amount of deposits that banks can lend out. In other words, the deposit creating ability of the banking system will increase. ##
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QUESTION 57 (NEW) Which of the following can explain the shift of the money demand curve from Md0 to Md1? Nominal interest rate
0 A. B. C. D. The nominal interest rate increases. Households real income decreases. More people use electronic money. The price level increases.
Md0
Md1 Quantity of money
## D The increase in the price level will lead to an increase in nominal income, leading to an increase in transaction demand for money. The money demand curve will therefore shift to the right. ##
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Short Questions QUESTION 01 Read the following information of a banking system.
million ($) Currency held by the public Demand deposits with licensed banks Savings deposits and time deposits with licensed banks Negotiable certificates of deposit (NCDs) issued by licensed banks held outside the banking system Deposits with restricted licence banks and deposit-taking companies Negotiable certificates of deposit (NCDs) issued by restricted licence banks and deposit-taking companies held outside the banking system 200 250 600 80 75 60
(a)
Calculate money supply M1, M2 and M3.
(3 marks) (1 mark)
(b) Which definition of money supply has the broadest coverage?
## (a) M1 = Currency held by the public + Demand deposits with licensed banks = $(200 + 250) million = $450 million (1 mark)
M2 = M1 + Savings deposits and time deposits with licensed banks + Negotiable certificates of deposit (NCDs) issued by licensed banks held outside the banking system = $(450 + 600 + 80) million = $1,130 million (1 mark)
M3 = M2 + Deposits with restricted licence banks and deposit-taking companies + Negotiable certificates of deposit (NCDs) issued by restricted licence banks and deposit-taking companies held outside the banking system = $(1,130 + 75 + 60) million = $1,265 million (b) M3. ## (1 mark) (1 mark)
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QUESTION 02 (a) What are the components of money supply M1, M2 and M3 respectively? (3 marks)
(b) David withdraws $5,000 from his current account from a licensed bank and uses it to buy the negotiable certificates of deposit (NCDs) issued by a deposit-taking company. How would money supply M1, M2 and M3 be affected? (3 marks)
## (a) M1 = Currency held by the public + Demand deposits with licensed banks (1 mark)
M2 = M1 + Saving deposits and time deposits with licensed banks + Negotiable certificates of deposit (NCDs) issued by licensed banks held outside the banking sector (1 mark)
M3 = M2 + Deposits with restricted licence banks and deposit-taking companies + Negotiable certificates of deposit (NCDs) issued by restricted licence banks and deposit-taking companies held outside the banking sector (1 mark)
(b) When David withdraws $5,000 from his current account from a licensed bank, the decrease in demand deposits with licensed banks is offset by the increase in currency held by the public. As the negotiable certificates of deposit (NCDs) issued by a deposit-taking company are included only in M3, M1 and M2 would decrease by $5,000 and M3 would remain unchanged. (3 marks) ##
QUESTION 03 (a) How will the amount of money supply M1, M2 and M3 be affected if a million of reserves are robbed from the treasury of a bank? Explain. (2 marks)
(b) How will the amount of money supply M1, M2 and M3 be affected if the central bank retrieved 30,000 pieces of fake 10-dollar coins from the public? Explain. (2 marks)
## (a) M1, M2 and M3 will remain unchanged. Reserves held by banks in the banking system are not included in money supply. (2 marks)
(b) Cash in public circulation falls by $300,000 (30,000 $10). M1, M2 and M3 will fall by $300,000. ## (2 marks)
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QUESTION 04 (a) Fanny withdraws $17,000 from her time deposit account from a licensed bank and keeps it at home. What is the immediate effect of Fannys action on money supply M1 and M2? Explain. (2 marks) (b) How will your answer in (a) change if Fanny withdraws this sum of money from her current account with the same bank instead of her time deposit account? Explain. (2 marks)
## (a) The above actions lead to an increase in currency held by the public by $17,000 and a fall in time deposits with licensed banks by $17,000. M1 will increase by $17,000 while M2 will remain unchanged. (2 marks)
(b) The decrease in demand deposits with licensed banks is offset by the increase in currency held by the public. Both M1 and M2 will remain unchanged. ## (2 marks)
QUESTION 05 Mr. Lau deposits $2,400 cash into a bank. Assume all banks in the banking system hold no excess reserves and the required reserve ratio is 12%. Explain the deposit creation process of Mr. Laus deposit, and determine the maximum possible increase of money supply. (6 marks)
## When Mr. Lau deposits $2,400 into a bank, the bank keeps $288 ($2,400 12%) as reserves and lends the remaining $2,112 ($2,400 $288) to other borrowers. Assuming there is no cash leakage, the borrowers will redeposit the loan with another bank. This bank keeps $253.44 ($2,112 12%) as reserves and lends the remaining $1858.56 ($2,112 $253.44) to other borrowers. The borrowers will deposit the loan with another bank. If the above process of deposit creation continues, deposits and loans within the banking system will continue to be created until there are no excess reserves to lend out. (4 marks)
The maximum possible increase of money supply = $2,400 (1 / 12%) $2,400 = $17,600 (2 marks) ##
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QUESTION 06 In a banking system, there is a total of $800,000 deposits. Banks have $200,000 reserves, in which $40,000 are kept as excess reserves. (a) Find the required reserve ratio and actual reserve ratio. (b) Determine the maximum banking multiplier and actual banking multiplier. (2 marks) (2 marks)
## (a) Required reserve ratio = Required reserves / Total deposits = ($200,000 $40,000) / $800,000 = 20% Actual reserve ratio = Actual reserves / Total deposits = $200,000 / $800,000 = 25% (b) Maximum banking multiplier = 1 / Required reserve ratio = 1 / 20% = 5 Actual banking multiplier = 1 / Actual reserve ratio = 1 / 25% = 4 ## (1 mark) (1 mark) (1 mark) (1 mark)
QUESTION 07 The table below shows the balance sheet of a banking system.
Assets ($) Reserves Loans and investment X 3X Deposits
(a) If the required reserve ratio is 10%, find the value of X, the amount of required reserves and excess reserves. (3 marks)
(b) If the required reserve ratio is 30%, find the amount of required reserves and excess reserves. (2 marks)
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## (a) In principle, on a balance sheet, the sum of the assets side should be equal to that of the liabilities side. Therefore, X + 3X = $100,000 X = $25,000 Required reserves = $100,000 10% = $10,000 Excess reserves = $25,000 $10,000 = $15,000 (b) Required reserves = $100,000 30% = $30,000 Excess reserves = $25,000 $30,000 = -$5,000 (a shortage of reserves) ## (1 mark) (1 mark) (1 mark) (1 mark) (1 mark)
QUESTION 08 Explain whether the process of deposit creation can take place if (a) there is only one bank in the banking system. (b) the interest rates of all kinds of deposits become zero. (3 marks) (3 marks)
## (a) Yes. (1 mark)
Deposit creation can take place as long as the required reserve ratio is smaller than 100% and there is demand for loans. It does not relate to the number of banks in the banking system. (2 marks) (b) Yes. (1 mark)
If the interest rates of all kinds of deposits become zero, people are less willing to deposit money into banks. Nevertheless, people may still deposit money into banks for reasons other than receiving interest, e.g. issuing cheques by drawing money from current account. The process of deposit creation can still take place. ## (2 marks)
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QUESTION 09 In a banking system, there are $1,500 of deposits and $300 of reserves. The public keep $1 as cash for every $5 deposit. (a) If all the banks in the banking system are fully loaned up, calculate the required reserve ratio. (2 marks) (b) If $200 of newly printed banknotes are issued by the central bank, calculate the maximum possible amount of deposits in the banking system. (4 marks)
## (a) If all the banks in the banking system are fully loaned up, the amount of reserves kept by banks is equal to the amount of required reserves. Required reserve ratio = Required reserves / Total deposits = $300 / $1,500 = 20% (b) As the public keep $1 as cash for every $5 deposit, the currency deposit ratio is 20%. The maximum possible amount of deposits from the newly printed banknotes = $200 / (20% + 20%) = $500 The maximum possible amount of deposits in the banking system = $1,500 + $500 = $2,000 ## (1 mark) (2 marks) (2 marks) (1 mark)
The banking system has excess reserves of $100. When someone withdraws $100 from the banking system, does it imply that there will be no excess reserves in the banking system? Explain. (4 marks)
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## No. Required reserve ratio = ($300 $100) / $1,000 = 20% (1 mark) (1 mark)
When someone withdraws $100 from the banking system, the balance sheet of the banking system will change immediately as below: Assets ($) Reserves Loans 200 700 (1 mark) (1 mark) Deposits Liabilities ($) 900
As the amount of deposits is $900, required reserve = $900 20% = $180. There will be excess reserves of $20. ##
QUESTION 11 Someone deposits $10,000 cash into a banking system. Assume the legal reserve ratio is 20%. (a) Compare the maximum possible increase in money supply and the maximum possible increase in deposits in the banking system through the process of credit creation. (4 marks)
(b) If the $10,000 cash is remitted from foreign countries, how will you answer for (a) change? Explain. ## (a) Money supply = Currency in public circulation + Bank deposits Maximum possible increase in money supply = -$10,000 + $10,000 / 20% = $40,000 Maximum possible increase in deposits = $10,000 / 20% = $50,000 (1 mark) (1 mark) (1 mark) (3 marks)
The maximum possible increase in money supply is smaller than the maximum possible increase in deposits in the banking system. (1 mark)
(b) If the $10,000 cash is remitted from foreign countries, there will be no change in currency in public circulation. Maximum possible increase in money supply = $10,000 / 20% = $50,000. (2 marks)
The maximum possible increase in money supply is equal to the maximum possible increase in deposits in the banking system. ## (1 mark)
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Assume banks do not hold excess reserves and the public initially holds $400 cash. (a) Calculate the maximum banking multiplier. (b) Suppose Miss Cheung deposits $50 cash into a bank. After the deposit creation process, (i) (ii) how much will the amount of deposits in the banking system be? how much will the money supply be? (1 mark) (2 marks) (2 marks)
## (a) Required reserve ratio = $1,500 / $6,000 = 25% Maximum banking multiplier = 1 / 25% = 4 (b) (i) (ii) The amount of deposits = $6,000 + $50 / 25% = $6,200 Money supply = Cash in public circulation + Bank deposits = $(400 50) + $6,200 = $6,550 ## (2 marks) (1 mark) (1 mark) (1 mark)
QUESTION 13 (a) Define what a money multiplier is. (b) How will the money multiplier of an economy change if there is (i) (ii) a rise in the required reserve ratio? (3 marks) (1 mark)
a decrease in the amount of cash in public circulation due to increased amount of overseas remittance to other countries? (3 marks)
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## (a) Money multiplier = Money supply / Monetary base (b) (i) (1 mark)
If there is a rise in the required reserve ratio, there will be a fall in bank deposits and thus a fall in money supply. Given the monetary base remains unchanged, the money multiplier will fall. (3 marks)
(ii)
If there is a decrease in the amount of cash in public circulation, given the amount of bank deposits and bank reserves remains unchanged, money supply and monetary base will fall by the same amount. The money multiplier will thus increase. (3 marks)
##
QUESTION 14 (a) Explain why the money supply of an economy is often greater than the monetary base. (4 marks)
(b) Under what circumstance will the money supply of an economy be equal to the monetary base? (2 marks)
## (a) Money supply = Cash in public circulation + Bank deposits Monetary base = Currency in public circulation + Bank reserves (1 mark) (1 mark)
Bank deposits are usually greater than bank reserves. With a fractional reserve system, banks can lend money to the public with excess reserves after holding the required amount of reserves. Through the process of deposit creation, money supply will increase and become greater than the monetary base. (2 marks)
(b) When bank deposits equal bank reserves, the money supply of an economy equals the monetary supply. This happens only when the process of credit creation does not exist. ## (1 mark) (1 mark)
QUESTION 15 (a) Explain the two main purposes of holding money. (4 marks)
(b) In a barter economy, will people have a demand for money? Use your answer in (a) to explain. (5 marks)
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## (a) Since money is a medium of exchange, money is needed to make daily transactions of goods and services. Since the time of receiving income and making purchases may not be the same, people hold money to finance their expenses. This is the transaction demand for money. (2 marks)
People also hold money as a form of assets to store their wealth. This is the asset demand for money. (b) No. (2 marks) (1 mark)
People will not have transaction demand for money, as people exchange goods for other goods without using money as a medium of exchange. (2 marks)
People will not have asset demand for money, as money does not exist. People can only store goods as wealth. ## (2 marks)
QUESTION 16 How would the demand for money be affected under the following circumstances? (a) an increase in nominal interest rate (b) an increase in nominal income (c) a decrease in the transaction cost of using electronic money (2 marks) (2 marks) (2 marks)
## (a) When the nominal interest rate increases, asset demand for money decreases while transaction demand for money is not affected. The total quantity demanded for money will decrease. Demand for money will remain unchanged. (2 marks)
(b) When nominal income increases, transaction demand for money increases while asset demand for money is not affected. Total demand for money will increase. (2 marks)
(c) With a decrease in the cost of using electronic money, people will reduce the amount of money held for transactions. Transaction demand for money decreases while asset demand for money is not affected. Total demand for money will decrease. ## (2 marks)
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QUESTION 17 (a) List TWO reasons why banks usually keep excess reserves. (4 marks)
(b) How would the existence of excess reserves affect the central banks ability to control the money supply? (3 marks)
## (a) For safety reasons, banks may deliberately keep a reserve ratio higher than that required by the government to cope with possible emergency situations, e.g. bank run. (2 marks)
Banks may not be able to lend out all their excess reserves because there is insufficient demand for loans. If the economy is not good or the interest rates are high, borrowing from banks will decrease. At this point, banks have no choice but to keep excess reserves. (2 marks)
(b) With the existence of excess reserves, the central bank cannot fully control the money supply. It will reduce the central banks ability to control the money supply. Suppose the central bank intends to reduce money supply by raising the required reserve ratio. If banks hold excess reserves, they may not need to recall loans to meet the new requirement of the required reserve ratio. In this case, raising the required reserve ratio may not be able to reduce money supply. marks) ## (3
QUESTION 18 How the money market would be affected if people expect the interest rate of government bonds to increase? (4 marks)
## If people expect the interest rate of government bonds to increase, they will buy more government bonds and hold less money as assets. Asset demand for money will decrease while transaction demand for money will not be affected. Demand for money will decrease. (2 marks)
Given the money supply remains unchanged, the equilibrium interest rate will decrease and the equilibrium quantity of money will remain unchanged. ## (2 marks)
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QUESTION 19 When the nominal interest rate of a country decreases, how would the following items be affected? (a) the amount of money held by the public (b) consumption expenditures (c) foreign investment (2 marks) (2 marks) (2 marks)
## (a) When the nominal interest rate decreases, asset demand for money increases while transaction demand for money is not affected. The total quantity demanded for money will increase. The amount of money held by the public will increase. (2 marks)
(b) When the interest rate of a country decreases, consumption expenditures will increase because the interest rate is the opportunity cost of funds used to finance consumption spending. (2 marks)
(c) When the interest rate of a country decreases, if interest rates in other countries remain constant, there will be an outflow of capital from the country to other countries in order to earn a higher interest rate. Foreign investment will decrease. ## (2 marks)
QUESTION 20 (NEW) Refer to the following balance sheet of a banking system which has an excess reserve of $1,000.
Suppose someone withdraws $500 from the banking system. If there is no cash leakage and the banks still hold an excess reserve of $1,000, calculate the following items after the process of deposit contraction is completed: (a) Deposits (3 marks) (2 marks)
(b) Loans
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## (a) Required reserve ratio = Required reserves / Total deposits = ($5,000 $1,000) / $16,000 = 25% When someone withdraws $500 from the banking system, the amount of reserves will become $5,000 $500 = $4,500. If the banks still hold an excess reserve of $1,000, the amount of deposits = $(4,500 1,000) 1 / 25% = $14,000 (b) Loans = $(14,000 4,500) = $9,500. ## (3 marks) (2 marks)
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Long Questions QUESTION 01 George withdraws $120,000 from his savings account with a licensed bank. He remits $30,000 to his cousin in Canada and deposits the remaining money into a deposit-taking company. (a) Are savings deposits with a licensed bank included in M1, M2 and M3? (3 marks)
(b) What is the immediate effect of Georges action on the Hong Kong money supply M1, M2 and M3? (3 marks)
(c) Name TWO types of deposits that are not mentioned above. If they are with a licensed bank, are they included in M2? (3 marks)
## (a) M1 includes currency held by the public and demand deposits with licensed banks. Saving deposits with a licensed bank are not included in M1. (1 mark)
M2 includes all the components of M1, as well as saving deposits and time deposits with licensed banks, and negotiable certificates of deposit issued by licensed banks held outside the banking sector. Savings deposits with a licensed bank are included in M2. (1 mark)
M3 includes all of the components of M2, as well as the deposits with restricted licence banks and deposit-taking companies, and negotiable certificates of deposit issued by restricted licence banks and deposit-taking companies held outside the banking sector. Savings deposits with a licensed bank are included in M3. (b) George withdraws $120,000 from his savings account with a licensed bank He remits $30,000 to his cousin in Canada He deposits the remaining money ($90,000) into a deposit-taking company Net change M1 +$120,000 -$30,000 -$90,000 0 M2 ----$30,000 -$90,000 -$120,000 M3 ----$30,000 ----$30,000 (3 marks) (1 mark)
M1 remains unchanged, M2 decreases by $120,000 and M3 decreases by $30,000.
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(c)
- demand deposit - time deposit - negotiable certificate of deposit (NCD) (Mark the FIRST TWO points only, 1 mark each) If they are with a licensed bank, they are included in M2. (1 mark)
##
QUESTION 02 The following table shows the balance sheet of Bank XYZ.
Assets ($) Reserves Loans 350 1,150 Deposits
Suppose Bank XYZ is the only bank in the banking system and the required reserve ratio is 20%. (a) Calculate the excess reserves and maximum banking multiplier. (b) If the required reserve ratio increases to 25%, how would your answer in (a) be affected? (2 marks) (c) From your answer in (a) and (b), what is the relationship between the required reserve ratio and the maximum banking multiplier? (2 marks) (2 marks)
(d) Adjusting the required reserve ratio is one of the methods used by the central bank to manipulate money supply. Using the case of bank XYZ as an example, briefly explain how it works.(4 marks)
## (a) Excess reserves = Actual reserves Required reserves = $350 ($1,500 20%) = $50 Maximum banking multiplier = 1 / Required reserve ratio = 1 / 20% =5 (1 mark) (1 mark)
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(b) Excess reserves = $350 ($1,500 25%) = -$25 (a shortage of reserves) Maximum banking multiplier = 1 / 25% =4 (c) When the required reserve ratio increases, the maximum banking multiplier decreases. They are negatively related. (1 mark) (1 mark) (1 mark) (1 mark)
(d) If the central bank wants to decrease the money supply, it may increase the required reserve ratio. Given the same amount of reserves held, Bank XYZ will not have sufficient reserves to fulfil the minimum reserve requirement. In order to satisfy the higher reserve ratio, it needs to reduce its lending or even call back loans from the public. Through deposit contraction, money supply will decrease. ## (4 marks)
Assets ($) Reserves Loans 375 2,125 Deposits
Suppose the banks do not hold any excess reserves. The public initially holds $200 cash. (a) Find the minimum reserve ratio, actual reserve ratio and maximum banking multiplier. (b) Suppose Jane withdraws $50 from a bank. (i) (ii) How much is the maximum possible amount of deposits? Determine the amount of money supply after the process of credit creation. (2 marks) (2 marks) (3 marks) (3 marks)
(iii) Find the money multiplier.
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## (a) Minimum reserve ratio = Required reserves / Total deposits = $375 / $2,500 = 15% Actual reserve ratio = Actual reserves / Total deposits = $375 / $2,500 = 15% Maximum banking multiplier = 1 / Required reserve ratio = 1 / 15% = 6.67 (b) (i) Maximum possible amount of deposits = ($375 $50) 1 / 0.15 = $2,167 (ii) Money supply = Cash in public circulation + Bank deposits = ($200 + $50) + $2,167 = $2,417 (iii) Monetary base = Currency in public circulation + Bank reserves = $250 + $325 = $575 Money multiplier = Money supply / Monetary base = $2,417 / $575 = 4.203 ## (2 marks) (1 mark) (2 marks) (2 marks) (1 mark) (1 mark) (1 mark)
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QUESTION 04 The following table shows the balance sheet of Bank ABC. Assume the required reserve ratio is 20%.
Assets ($) Reserves Loans Investment 1,200 3,000 800 Deposits
(a) Compare the actual reserve ratio and the required reserve ratio. (b) Explain whether Bank ABC meets the minimum reserve requirement. (c) Someone withdraws $300 from Bank ABC. (i)
(2 marks) (2 marks)
What will be the immediate effect to Bank ABCs balance sheet? Compare the new amounts of actual reserves and required reserves. (4 marks)
(ii) After the withdrawal, Bank ABC cannot meet the minimum reserve requirement. Suggest THREE possible methods for Bank ABC to meet the minimum reserve requirement. (3 marks)
## (a) Actual reserve ratio = Actual reserves / total deposits = $1,200 / $5,000 = 24% The actual reserve ratio is higher than the required reserve ratio (20%). (b) Required reserves = $5,000 20% = $1,000 (1 mark) (1 mark) (1 mark)
Bank ABCs actual reserves ($1,200) are higher than the required reserves. Bank ABC can meet the minimum reserve requirement. (1 mark)
(c) If someone withdraws $300 from Bank ABC, the balance sheet of the bank will change as below: Assets ($) Reserves Loans Investment 900 3,000 800 (2 marks) With the $4,700 deposits, the required reserve should be $940 ($4,700 20%). The actual reserves ($900) are lower than the required reserve. (2 marks) Deposits Liabilities ($) 4,700
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(d) - borrow money from the central bank at the discount rate - recall loans - reduce investment - sell some of the assets to the public (Mark the FIRST THREE points only, 1 mark each) ##
QUESTION 05 Study the table below. Money supply ($) Transaction demand for money ($) Asset demand for money ($) Nominal interest rate (%) 60 30 20 12 60 30 25 11 60 30 30 10 60 30 35 9 60 30 40 8 (2 marks) (2 marks)
(a) What is the equilibrium interest rate in the money market? (b) If the money supply decreases to $50, what is the new equilibrium interest rate? (c) How would you expect the equilibrium nominal interest rate to change if there is (i) an increase in the peoples nominal income?
(3 marks) (3 marks)
(ii) a decrease in the interest rate of government bonds?
## (a) Transaction demand for money ($) Asset demand for money ($) Total money demand ($) Money supply ($) Nominal interest rate (%) 30 20 50 60 12 30 25 55 60 11 30 30 60 60 10 30 35 65 60 9 30 40 70 60 8
When the total demand for money is equal to the money supply ($60), the money market is in equilibrium. The equilibrium nominal interest rate is 10%. (2 marks)
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(b) Transaction demand for money ($) Asset demand for money ($) Total money demand ($) Money supply ($) Nominal interest rate (%) 30 20 50 50 12 30 25 55 50 11 30 30 60 50 10 30 35 65 50 9 30 40 70 50 8 (2 marks)
If the money supply decreases to $50, the equilibrium nominal interest rate is 12%. (c) (i)
If there is an increase in peoples nominal income, transaction demand for money increases while asset demand for money is not affected. Demand for money will increase. (2 marks)
Given the money supply remains unchanged, the nominal interest rate will increase. (1 mark) (ii) When holding money, people forgo the return on holding other interest-bearing assets. If there is a decrease in the interest rate of government bonds, the opportunity cost of holding money decreases. Asset demand for money increases while transaction demand for money is not affected. Demand for money will increase. (2 marks)
Given the money supply remains unchanged, the nominal interest rate will increase. (1 mark) ##
QUESTION 06 (NEW) The following table shows the balance sheet of the banking system of an economy:
Suppose the banking system of the economy holds an excess reserve of $500 and the public holds $1,000 cash. (a) Calculate the monetary base and money supply of the economy. (2 marks) (2 marks)
(b) Calculate the required reserve ratio. Show your steps. (c)
Suppose the public decides not to hold cash anymore and deposits the cash in hand into the banking system. (i) Calculate the amounts of reserves, loans and deposits in the balance sheet of the banking system after the process of deposit creation is completed if all the excess reserves are loaned out. Show your steps. (ii) Explain briefly the deposit creation process resulting from the above change. (6 marks) (4 marks)
## (a) Monetary base = $1,000 + $3,000 = $4,000 (1 mark)
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Money supply = $1,000 + $12,500 = $13,500 (b) Required reserve ratio = $(3,000 500) / $12,500 100% = 20% (c) (i) Reserves = $(3,000 + 1,000) = $4,000 Deposits = $4,000
1 = $20,000 20%
(1 mark) (2 marks) (2 marks) (2 marks) (2 marks)
Loans = $(20,000 4,000) = $16,000
(ii) When the public deposits the cash in hand into the banking system, the reserves increase by the amount deposited, but the required reserves increase by only a fraction of the amount deposited. There will be excess reserves in the bank and the bank can loan out the excess reserves. These loans can end up as deposits in the banking system. The process goes on and on until the actual reserve is equal to the desired reserve. ## (4 marks)
20-59

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What are the different definitions of money supply?

What are the different definitions of money supply?

What does M1 consist of?

What does M1 consist of?

Economics Inquiry for HKDSE Macroeconomics 1 Chapter 20 Money Supply and Money Demand

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QUESTION 10 Study the following table.

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M1 remains unchanged while M2 and M3 decrease. ##

## D (1) is incorrect. M1 consists of non-interest-bearing components only. ##

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Assets ($) Reserves Loans 250 750 Deposits

Liabilities ($) 1,000

Aristo Educational Press Ltd.

Assets ($) Reserves Loans 300 900 Deposits

Liabilities ($) 1,200

Aristo Educational Press Ltd.

Assets ($) Reserves Loans 1,000 4,000 Deposits

Liabilities ($) 5,000

Aristo Educational Press Ltd.

Aristo Educational Press Ltd.

Assets ($) Reserves Loans and investments 600 1,400 Deposits

Liabilities ($) 2,000

Aristo Educational Press Ltd.

Assets ($) Reserves Loans and investments 300 1,200 Deposits

Liabilities ($) 1,500

Aristo Educational Press Ltd.

Assets ($) Reserves Loans and investments 450 1,350 Deposits

Liabilities ($) 1,800

Aristo Educational Press Ltd.

Aristo Educational Press Ltd.

Assets ($) Reserves Loans and investments 700 1,300 Deposits

Liabilities ($) 2,000

Assets ($) Cash reserves Loans

Liabilities ($) 800 2,200 Deposits 3,000

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Aristo Educational Press Ltd.

Aristo Educational Press Ltd.

Aristo Educational Press Ltd.

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Aristo Educational Press Ltd.

Aristo Educational Press Ltd.

Aristo Educational Press Ltd.

Aristo Educational Press Ltd.

Aristo Educational Press Ltd.

Aristo Educational Press Ltd.