Econ QB QB_Ch20 (ENG)

Economics Inquiry for HKDSE – Macroeconomics 1Chapter 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. (2) only

B. (3) only

C. (1) and (2) only

D. (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. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (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.

##

© Aristo Educational Press Ltd. 20-1


QUESTION 03

Banknotes held by banks _______________ in money supply M1, because _______________.

A. is included … their value is rather stable

B. is included … the liquidity of these banknotes is very high

C. is not included … these banknotes are not used as a medium of exchange

D. is not included … they cannot fulfil the function of money as a store of value

##

C


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. money supply M1

B. money supply M2

C. money supply M3

D. None of the above.

##

A


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.

##



QUESTION 05

Which of the following about money supply M1 is CORRECT?

A. Time deposits are included in M1.

B. M1 is the broadest definition of money supply.

C. Negotiable certificates of deposit are included in M1.

D. M1 consists of non-interest-bearing components only.

##

D


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. medium of exchange

B. store of value

C. unit of account

D. 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.

##



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. (1) and (2) only

B. (3) and (4) only

C. (1), (2) and (3) only

D. (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


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. (2) only

B. (1) and (4) only

C. (2) and (3) only

D. (2), (3) and (4) only



##

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. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

D


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.

##



QUESTION 10

Study the following table.

$ billion

Currency held by the public 2

Demand deposits 5

Deposits with licensed banks 12

Deposits with restricted licence banks and

deposit-taking companies20

Negotiable certificates of deposit issued by

licensed banks, restricted licence banks and

deposit-taking companies

18

The money supply M2 of this economy is

A. $7 billion.

B. $19 billion.

C. $57 billion.

D. 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


As we cannot get the figure of negotiable certificates of deposit issued only by licensed banks, we

cannot determine the figure of M2.

##



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. Both money supply M1 and M2 decrease.

B. Both money supply M1 and M2 increase.

C. Money supply M1 remains unchanged while money supply M2 decreases.

D. Money supply M1 increases while money supply M2 remains unchanged.

##

D

M1 M2

Peter withdraws $30,000 from his time deposit

account in a licensed bank+$30,000

He transfers $30,000 to his current account in the

same bank-----

Net change +$30,000 0

M1 increases while M2 remains unchanged.

##

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. Both money supply M1 and M3 increases.

B. Both money supply M1 and M3 decrease.

C. Money supply M1 increases while money supply M3 remains unchanged.

D. Money supply M1 remains unchanged while money supply M3 decreases.



##

C


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. Jenny deposits a certain amount of cash into her current account.

B. Lily uses the cash in hand to buy a negotiable certificate of deposit issued by a licensed

bank.

C. Mary buys a car by cheque and the seller deposits the amount into his current account.

D. 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


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.

##



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. M1.

B. M2.

C. M2 and M3.

D. M1, M2 and M3.

##

A


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. remains unchanged … decreases … decreases

B. remains unchanged … decreases … increases

C. decreases … decreases … decreases

D. increases … remains unchanged … remains unchanged



##

A

M1 M2 M3

Mr. Wong withdraws $80,000 from his

time deposit account in a licensed bank

+$80,000 ---- ----

He remits $50,000 to his mother in the US -$50,000 -$50,000 -$50,000

He deposits the remaining $30,000 into a

restricted licence bank

-$30,000 -$30,000 ----

Net change 0 -$80,000 -$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. (1) only

B. (3) only

C. (1) and (2) only

D. (2) and (3) only

##

D

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

##



QUESTION 17

Jane remits $4,000 cash in hand to Japan. What is the immediate effect of Jane’s action on the money

supply of Hong Kong?

A. Money supply M1, M2 and M3 remain unchanged.

B. Money supply M1, M2 and M3 decrease.

C. Money supply M1 and M2 decrease while money supply M3 remains unchanged.

D. 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. 10% … $30,000

B. 10% … $80,000

C. 16% … $30,000

D. 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

##



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. (1) only

B. (3) only

C. (1) and (2) only

D. (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. 5

B. 20

C. 3.33

D. 4



##

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. $0.

B. $3,000.

C. $20,000.

D. 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.

##



QUESTION 22

The following table shows the balance sheet of a banking system. No banks hold excess reserves.

Assets ($) Liabilities ($)

Reserves 250

Loans 750

Deposits 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. (2) only

B. (1) and (2) only

C. (2) and (3) only

D. (1), (2) and (3)

##

A

After the withdrawal, the balance sheet is as below:


Reserves 150

Loans 750

Deposits 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).

##



QUESTION 23

The following table shows the balance sheet of a banking system.


Reserves 300

Loans 900

Deposits 1,200

Assume the legal reserve ratio is 15%. Which of the following statements is INCORRECT?

A. The required reserves are $180.

B. The actual banking multiplier is 6.67.

C. There are excess reserves of $120.

D. 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

##



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%.


Reserves 1,000

Loans 4,000

Deposits 5,000

(a) The money supply of this economy is

A. $5,000.

B. $5,500.

C. $6,000.

D. $27,500.

(b) Suppose $600 of banknotes are issued by the government. The maximum amount of deposits in

the banking system is

A. $5,600.

B. $7,000.

C. $7,700.

D. $8,000.

##

(a) B

Money supply = Cash in public circulation + Bank deposits

= $5,000 10% + $5,000

= $5,500



(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. $0

B. $50,000

C. $100,000

D. $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

##



QUESTION 26

The following table shows the balance sheet of Bank ABC.


Reserves 600

Loans and investments 1,400

Deposits 2,000

If the excess reserves are $150, which of the following is CORRECT?

A. The required reserves are $400.

B. The actual reserve ratio is smaller than the required reserve ratio.

C. The maximum banking multiplier is 4.44.


##

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%.

##



QUESTION 27

The following table shows the balance sheet of a banking system. There are excess reserves of $100.


Reserves 300


Deposits 1,500

The minimum reserve ratio is _______________ and the actual reserve ratio is _______________.

A. 6.7% … 13.33%

B. 6.7% … 20%

C. 13.33% … 20%

D. 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. $800

B. $1,000

C. $2,000

D. There is insufficient information to answer.

##

B

Maximum increase in deposits in the banking system = $200 / (10% + 10%) = $1,000

##



QUESTION 29

The following table shows the balance sheet of a bank. The minimum reserve ratio of the banking

system is 20%.


Reserves 450


Deposits 1,800

If the bank lends out all the excess reserves, the amount of deposits after credit creation process is

_______________.

A. $1,800

B. $1,900

C. $2,160

D. $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. increase

B. decrease

C. remain unchanged

D. increase or decrease



##

C


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. The excess reserves are always zero.

B. When someone deposits $10,000 cash into his or her current account, the money supply

remains unchanged.

C. The maximum banking multiplier is 1.

D. The monetary base of the economy is smaller than the money supply.

##

D


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

##



QUESTION 32



Reserves 700


Deposits 2,000

Suppose there are excess reserves of $500. Which of the following statements is CORRECT?

A. The actual banking multiplier is 10.

B. The required reserve ratio is 35%.

C. The maximum possible amount of deposits created is $7,000.


##

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%.


Cash reserves 800

Loans 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. $50 … $2,200

B. $200 … $2,800

C. $2,400 … $3,200

D. $3,200 … $2,400



##

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. banks decide to hold more reserves.

B. the central bank raises the minimum reserve ratio.

C. more new coins are issued by the central bank.

D. All of the above.

##

C


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.

##



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. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

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. (4) only

B. (1) and (3) only

C. (2) and (4) only

D. (1), (2) and (4) only



##

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 Kong’s money supply

is

A. $10,000.

B. $40,000.

C. $50,000.

D. $60,000.

##

C


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

##



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. bank deposits … money supply

B. bank deposits … bank reserves

C. monetary base … deposits

D. money supply … deposits

##

A


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. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)



##

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. (1) only

B. (1) and (2) only

C. (1) and (3) only

D. (2) and (3) only



##

B

(1) is correct.


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. total amount of deposits

B. currency held by public

C. demand for loans

D. 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. Monetary base is also called high-powered money.

B. Monetary base is always smaller than money supply.

C. Monetary base decreases if someone remits money to a foreign country.

D. Monetary base is the total amount of currency issued by the central bank.



##

B

Monetary base = Currency in public circulation + Bank reserves


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. transaction demand … more

B. transaction demand … less

C. asset demand … more

D. 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. (1) only

B. (1) and (2) only

C. (1) and (3) only

D. (2) and (3) only



##

C

(2) is incorrect.

M0 = Currency in public circulation + Bank reserves


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. the money supply curve will shift to the right.

B. the money demand curve will shift to the left.

C. the nominal interest rate will increase.


##

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.

##



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. (3) only

B. (1) and (2) only

C. (1) and (3) only


##

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. total demand for money … total demand for money

B. total demand for money … total quantity demanded for money

C. total quantity demanded for money … total demand for money

D. total quantity demanded for money … total quantity demanded for money



##

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. raise … increase

B. raise … decrease

C. lower … increase

D. 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.

##



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. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

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 country’s 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. transaction demand for money … increase

B. transaction demand for money … decrease

C. asset demand for money … increase

D. asset demand for money … decrease



##

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. decrease … decrease

B. decrease … increase

C. increase … increase

D. 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.

##



QUESTION 52

Study the table below.

Asset demand for

money ($)

Transaction demand

for money ($)Money supply ($)

Nominal interest rate

(%)

200 700 1,200 15

300 700 1,200 13

400 700 1,200 11

500 700 1,200 9

600 700 1,200 7

What is the equilibrium interest rate?

A. 7%

B. 9%

C. 11%

D. 13%

##

B

Total demand for money ($) Money supply ($) Nominal interest rate (%)

200 + 700 = 900 1,200 15

300 + 700 = 1,000 1,200 13

400 + 700 = 1,100 1,200 11

500 + 700 = 1,200 1,200 9

600 + 700 = 1,300 1,200 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%.

##



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 A’s

currency to other currencies will _______________.

A. inflow of capital to … increase

B. inflow of capital to … decrease

C. outflow of capital from … increase

D. 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

country’s currency to appreciate, i.e. the exchange rates of Country A’s 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. (2) only

B. (1) and (2) only

C. (2) and (3) only

D. (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.

##



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. Miss Chow withdraws $2,000 from her demand deposits and keeps it as cash.

B. Miss Yu transfers $2,000 from her demand deposits to savings deposits with a licensed bank.

C. Miss Lee receives $2,000 cash from overseas and deposits it in a restricted licence bank.

D. Miss So uses $2,000 cash in hand to buy a negotiable certificate of deposit issued by a

licensed bank.

##

C



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. The deposit creating ability of the banking system will increase.

B. The use of credit cards will become more popular.

C. The cash held by the public will decrease.

D. 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.

##



QUESTION 57 (NEW)

Which of the following can explain the shift of the money demand curve from Md0 to Md1?

A. The nominal interest rate increases.

B. Household’s real income decreases.

C. More people use electronic money.

D. The price level increases.

##

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.

##


Nominal interest rate

0Quantity of money

Md1

Md0


Short Questions

QUESTION 01

Read the following information of a banking system.

million ($)

Currency held by the public 200

Demand deposits with licensed banks 250

Savings deposits and time deposits with licensed banks 600

Negotiable certificates of deposit (NCDs) issued by licensed banks held

outside the banking system80

Deposits with restricted licence banks and deposit-taking companies 75

Negotiable certificates of deposit (NCDs) issued by restricted licence

banks and deposit-taking companies held outside the banking system60

(a) Calculate money supply M1, M2 and M3. (3 marks)

(b) Which definition of money supply has the broadest coverage? (1 mark)

##

(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)


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 (1 mark)

(b) M3. (1 mark)

##



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)


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)

##



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 Fanny’s 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. Lau’s

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)

##



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. (2 marks)

(b) Determine the maximum banking multiplier and actual banking multiplier. (2 marks)

##

(a) Required reserve ratio = Required reserves / Total deposits

= ($200,000 – $40,000) / $800,000 = 20% (1 mark)


= $200,000 / $800,000 = 25% (1 mark)

(b) Maximum banking multiplier = 1 / Required reserve ratio

= 1 / 20% = 5 (1 mark)

Actual banking multiplier = 1 / Actual reserve ratio

= 1 / 25% = 4 (1 mark)

##

QUESTION 07

The table below shows the balance sheet of a banking system.


Reserves X

Loans and investment 3X

Deposits 100,000

(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)



##

(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 (1 mark)

Required reserves = $100,000 10% = $10,000 (1 mark)

Excess reserves = $25,000 – $10,000 = $15,000 (1 mark)

(b) Required reserves = $100,000 30% = $30,000 (1 mark)

Excess reserves = $25,000 – $30,000 = -$5,000 (a shortage of reserves) (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. (3 marks)

(b) the interest rates of all kinds of deposits become zero. (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)

##



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% (2 marks)

(b) As the public keep $1 as cash for every $5 deposit, the currency deposit ratio is 20%. (1 mark)

The maximum possible amount of deposits from the newly printed banknotes

= $200 / (20% + 20%)

= $500 (2 marks)

The maximum possible amount of deposits in the banking system

= $1,500 + $500

= $2,000 (1 mark)

##

QUESTION 10



Reserves 300

Loans 700

Deposits 1,000

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)



##

No. (1 mark)

Required reserve ratio = ($300 – $100) / $1,000 = 20% (1 mark)

When someone withdraws $100 from the banking system, the balance sheet of the banking system will

change immediately as below:


Reserves 200

Loans 700

Deposits 900

As the amount of deposits is $900, required reserve = $900 20% = $180. (1 mark)

There will be excess reserves of $20. (1 mark)

##

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. (3 marks)

##

(a) Money supply = Currency in public circulation + Bank deposits (1 mark)

Maximum possible increase in money supply

= -$10,000 + $10,000 / 20%

= $40,000 (1 mark)

Maximum possible increase in deposits

= $10,000 / 20%

= $50,000 (1 mark)

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)



##

QUESTION 12



Reserves 1,500

Loans 4,500

Deposits 6,000

Assume banks do not hold excess reserves and the public initially holds $400 cash.

(a) Calculate the maximum banking multiplier. (2 marks)

(b) Suppose Miss Cheung deposits $50 cash into a bank. After the deposit creation process,

(i) how much will the amount of deposits in the banking system be? (1 mark)

(ii) how much will the money supply be? (2 marks)

##

(a) Required reserve ratio = $1,500 / $6,000 = 25% (1 mark)

Maximum banking multiplier = 1 / 25% = 4 (1 mark)

(b) (i) The amount of deposits = $6,000 + $50 / 25% = $6,200 (1 mark)

(ii) Money supply = Cash in public circulation + Bank deposits

= $(400 – 50) + $6,200 = $6,550 (2 marks)

##

QUESTION 13

(a) Define what a money multiplier is. (1 mark)

(b) How will the money multiplier of an economy change if there is

(i) a rise in the required reserve ratio? (3 marks)

(ii) a decrease in the amount of cash in public circulation due to increased amount of overseas

remittance to other countries? (3 marks)



##

(a) Money multiplier = Money supply / Monetary base (1 mark)

(b) (i) 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 (1 mark)

Monetary base = Currency in public circulation + Bank reserves (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. (1 mark)

This happens only when the process of credit creation does not exist. (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)



##

(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. (2 marks)

(b) No. (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 (2 marks)

(b) an increase in nominal income (2 marks)

(c) a decrease in the transaction cost of using electronic money (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)

##



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 bank’s 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 bank’s 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. (3

marks)

##

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)

##



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 (2 marks)

(b) consumption expenditures (2 marks)

(c) foreign investment (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.


Reserves 5,000

Loans 11,000

Deposits 16,000

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)

(b) Loans (2 marks)



##

(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 (3 marks)

(b) Loans = $(14,000 – 4,500) = $9,500. (2 marks)

##



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 George’s 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. (1 mark)

(b)

M1 M2 M3

George withdraws $120,000 from his savings account

with a licensed bank+$120,000 ---- ----

He remits $30,000 to his cousin in Canada -$30,000 -$30,000 -$30,000

He deposits the remaining money ($90,000) into a

deposit-taking company-$90,000 -$90,000 ----

Net change 0 -$120,000 -$30,000

M1 remains unchanged, M2 decreases by $120,000 and M3 decreases by $30,000. (3 marks)



(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.


Reserves 350

Loans 1,150

Deposits 1,500

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. (2 marks)

(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)

(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 (1 mark)


= 1 / 20%

= 5 (1 mark)



(b) Excess reserves

= $350 – ($1,500 25%)

= -$25 (a shortage of reserves) (1 mark)

Maximum banking multiplier

= 1 / 25%

= 4 (1 mark)

(c) When the required reserve ratio increases, the maximum banking multiplier decreases. (1 mark)

They are negatively related. (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)

##

QUESTION 03



Reserves 375

Loans 2,125

Deposits 2,500

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. (3 marks)

(b) Suppose Jane withdraws $50 from a bank.

(i) How much is the maximum possible amount of deposits? (2 marks)

(ii) Determine the amount of money supply after the process of credit creation. (2 marks)

(iii) Find the money multiplier. (3 marks)



##

(a) Minimum reserve ratio = Required reserves / Total deposits

= $375 / $2,500

= 15% (1 mark)


= $375 / $2,500

= 15% (1 mark)


= 1 / 15%

= 6.67 (1 mark)

(b) (i) Maximum possible amount of deposits

= ($375 – $50) 1 / 0.15

= $2,167 (2 marks)

(ii) Money supply = Cash in public circulation + Bank deposits

= ($200 + $50) + $2,167

= $2,417 (2 marks)

(iii) Monetary base = Currency in public circulation + Bank reserves

= $250 + $325

= $575 (1 mark)

Money multiplier = Money supply / Monetary base

= $2,417 / $575

= 4.203 (2 marks)

##



QUESTION 04

The following table shows the balance sheet of Bank ABC. Assume the required reserve ratio is 20%.


Reserves 1,200

Loans 3,000

Investment 800

Deposits 5,000

(a) Compare the actual reserve ratio and the required reserve ratio. (2 marks)

(b) Explain whether Bank ABC meets the minimum reserve requirement. (2 marks)

(c) Someone withdraws $300 from Bank ABC.

(i) What will be the immediate effect to Bank ABC’s 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% (1 mark)

The actual reserve ratio is higher than the required reserve ratio (20%). (1 mark)

(b) Required reserves = $5,000 20% = $1,000 (1 mark)

Bank ABC’s 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:


Reserves 900

Loans 3,000

Investment 800

Deposits 4,700

(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)



(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 ($) 60 60 60 60 60

Transaction demand for money ($) 30 30 30 30 30

Asset demand for money ($) 20 25 30 35 40

Nominal interest rate (%) 12 11 10 9 8

(a) What is the equilibrium interest rate in the money market? (2 marks)

(b) If the money supply decreases to $50, what is the new equilibrium interest rate? (2 marks)

(c) How would you expect the equilibrium nominal interest rate to change if there is

(i) an increase in the people’s nominal income? (3 marks)

(ii) a decrease in the interest rate of government bonds? (3 marks)

##

(a)



Total money demand ($) 50 55 60 65 70

Money supply ($) 60 60 60 60 60


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)



(b)



Total money demand ($) 50 55 60 65 70

Money supply ($) 50 50 50 50 50


If the money supply decreases to $50, the equilibrium nominal interest rate is 12%. (2 marks)

(c) (i) If there is an increase in people’s 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:


Reserves 3,000

Loans 9,500

Deposits 12,500

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)

(b) Calculate the required reserve ratio. Show your steps. (2 marks)

(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. (6 marks)



(ii) Explain briefly the deposit creation process resulting from the above change. (4 marks)

##

(a) Monetary base = $1,000 + $3,000 = $4,000 (1 mark)

Money supply = $1,000 + $12,500 = $13,500 (1 mark)

(b) Required reserve ratio = $(3,000 – 500) / $12,500 100% = 20% (2 marks)

(c) (i) Reserves = $(3,000 + 1,000) = $4,000 (2 marks)

Deposits = $4,000 = $20,000 (2 marks)

Loans = $(20,000 – 4,000) = $16,000 (2 marks)

(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)

##


Date post:	28-Apr-2015
Category:	Documents
Upload:	william-ma
View:	230 times
Download:	5 times

Econ QB QB_Ch20 (ENG)

Documents