AP Macro money supply and fractional reserve banking key terms
A comprehensive study set for AP Macroeconomics covering key terms related to money supply and fractional reserve banking, including definitions and applications.
Quiz(64 questions)
1. What is the primary purpose of using open market operations?
Terms in this Study Set(64)
Money Supply Basics(16)
What is the money supply?
The total amount of monetary assets available in an economy at a specific time. Includes cash, coins, and demand deposits.
True or False: M1 is broader than M2.
False. M1 includes the most liquid forms of money, while M2 includes M1 plus savings accounts and time deposits.
Fill in the blank: M2 equals _____ plus M1.
savings accounts, time deposits, and other near-money assets.
What does M1 consist of?
Currency in circulation, demand deposits, and travelers' checks.
What is the primary purpose of the money supply?
Facilitate transactions, store value, and provide a unit of account.
Question: How does an increase in money supply affect interest rates?
Typically, an increase in money supply lowers interest rates, encouraging borrowing and spending.
True or False: Currency is the only component of M1.
False. M1 also includes demand deposits and travelers' checks.
What is the formula for the money multiplier?
The money multiplier is calculated as , where RRR is the required reserve ratio.
Cause → Effect: Increasing the money supply leads to _____?
Increased spending and potentially inflation.
What is the required reserve ratio (RRR)?
The percentage of deposits that banks must hold in reserve and not lend out.
Fill in the blank: An expansionary monetary policy increases the money supply to _____ economic activity.
stimulate
Comparison: M1 vs M2?
M1 is liquid money; M2 includes M1 plus savings and time deposits.
What happens to the money supply when banks lend more?
The money supply increases due to the money multiplier effect.
What is a liquidity trap?
A situation where low interest rates fail to stimulate borrowing and spending.
Question: How does cash affect the money supply?
Cash increases the money supply directly, as it is included in M1.
True or False: Banks can lend all of their deposits.
False. Banks must hold a fraction as reserves according to the RRR.
Fractional Reserve Banking(16)
Fractional reserve banking definition?
A system where banks hold a fraction of deposits as reserves and lend the rest.
True or False: Banks must keep all deposits as reserves.
False. Banks only keep a fraction as reserves; they lend the majority.
What is the reserve requirement?
The minimum percentage of deposits banks must hold as reserves, set by the Federal Reserve.
Effects of fractional reserve banking?
- Increases money supply - Facilitates lending - Can lead to bank runs if not managed.
Fill in the blank: The money multiplier formula is __________.
Calculate the money supply increase: $1000 with a 10% reserve.
Total money supply = 10,000.
What happens during a bank run?
Many depositors withdraw funds simultaneously, risking bank insolvency.
Difference between required reserves and excess reserves?
Required reserves are the minimum needed; excess reserves are additional funds available for lending.
How does lending affect the money supply?
Lending increases the money supply as new deposits are created from loans.
Question: Why do banks lend money?
To earn interest, which is a primary source of bank profits.
True or False: Higher reserve requirements decrease money supply.
True. Higher requirements limit the amount banks can lend out.
What is a bank's balance sheet?
A financial statement showing the assets, liabilities, and equity of a bank.
Consequences of low reserves?
- Increased risk of insolvency - Potential liquidity issues.
Fill in the blank: The __________ is the ratio of reserves to deposits.
reserve ratio
Comparison: Excess reserves vs. total reserves?
Excess reserves are above required amounts; total reserves include all funds held.
What is the main purpose of reserves?
To ensure banks can meet withdrawal demands and maintain stability.
Monetary Policy Tools(16)
What is monetary policy?
The process by which a central bank (like the Federal Reserve) controls the money supply to achieve specific economic goals, such as controlling inflation, managing unemployment, and fostering economic growth.
What are the primary tools of monetary policy?
1. Open market operations 2. Discount rate 3. Reserve requirements
Open market operations → Effect?
Buying securities increases money supply; selling securities decreases it.
True or False: Lowering the discount rate encourages banks to lend more.
True. A lower discount rate reduces borrowing costs for banks, promoting more lending.
What is the discount rate?
The interest rate charged by central banks on loans to commercial banks, influencing overall lending rates in the economy.
Fill in the blank: Increasing reserve requirements __________ money supply.
decreases. Higher reserve requirements limit the amount banks can lend.
Compare expansionary vs. contractionary monetary policy.
Expansionary increases money supply (lower rates), while contractionary decreases it (higher rates).
Short example: What happens when the Fed buys bonds?
Money supply increases as banks receive funds, enabling them to lend more, stimulating economic activity.
What is quantitative easing?
A non-traditional monetary policy tool where the central bank buys financial assets to inject liquidity directly into the economy.
Effect of lowering reserve requirement?
Increases money supply as banks can lend more of their deposits.
True or False: Raising the discount rate makes borrowing cheaper.
False. Raising the discount rate makes borrowing more expensive for banks.
What is the purpose of monetary policy?
To manage economic stability by controlling inflation, employment levels, and overall economic growth.
How does the Fed target interest rates?
Through open market operations, adjusting the supply of money to achieve desired rates.
What is the primary goal of expansionary monetary policy?
To stimulate economic growth by increasing money supply and lowering interest rates.
Cause → Effect: What happens when the Fed raises interest rates?
Borrowing costs rise, leading to reduced consumer spending and investment.
What is a liquidity trap?
A situation where low interest rates fail to stimulate the economy, as people hoard cash instead of spending or investing.
Effects on the Economy(16)
How does an increase in money supply affect inflation?
Increased money supply can lead to higher inflation as more money chases the same amount of goods, raising prices.
True or False: Increased money supply always leads to economic growth.
False. While it can stimulate growth, excessive money supply may cause inflation without real growth.
Fill in the blank: The relationship between money supply and interest rates is _____.
Inversely related. An increase in money supply typically lowers interest rates.
What happens to unemployment when the money supply increases?
Increased money supply can lower unemployment in the short run by stimulating economic activity.
Cause → Effect: Expansionary monetary policy leads to _____
Increased spending → potential inflation.
Comparison: Short-run vs. long-run effects of money supply changes.
Short-run: Lower interest rates, higher output. Long-run: Prices adjust, real output returns to natural rate.
What is the impact of tightening the money supply?
It usually raises interest rates, slows economic growth, and can increase unemployment.
How does money supply affect consumer spending?
An increase in money supply generally boosts consumer spending, as more funds are available.
True or False: Lowering the money supply can control inflation.
True. By reducing the amount of money, demand decreases, which can help stabilize prices.
What is aggregate demand's relationship with money supply?
Increased money supply boosts aggregate demand by allowing more borrowing and spending.
Example: If the Fed increases the money supply by 10%, what might happen?
Interest rates could drop, leading to increased investment and potentially higher GDP.
What role does confidence play in the effects of money supply changes?
If consumers and businesses lack confidence, increased money supply may not lead to higher spending.
Fill in the blank: A decrease in money supply typically leads to _____ in output.
A decrease in output due to higher interest rates and reduced spending.
What is the liquidity effect?
The immediate impact of a change in money supply on interest rates, typically leading to lower rates with increased supply.
Cause → Effect: Increased money supply affects housing market how?
Lower mortgage rates → increased home purchases and housing prices.
Comparison: Inflation vs. deflation caused by money supply changes.
Inflation: Excess money supply. Deflation: Insufficient money supply leading to price drops.
Questions in this Study Set(64)
1. What is the primary purpose of using open market operations?
2. What is fractional reserve banking?
3. What is included in M1?
4. How does an increase in money supply typically affect inflation?
5. Which of the following actions would likely lead to an increase in the money supply?
6. What does the reserve requirement refer to?
7. True or False: M2 includes only cash and coins.
8. Which of the following is true regarding money supply and economic growth?
9. What effect does a contractionary monetary policy have on the economy?
10. True or False: Banks can lend out all deposits they receive.
11. What happens to the money supply when the Federal Reserve buys government securities?
12. Fill in the blank: Increasing the money supply will likely lead to _____ in the short run.
13. Which of the following is NOT a tool of monetary policy?
14. Which of the following increases the money supply?
15. Fill in the blank: The money multiplier is defined as _____ divided by the required reserve ratio.
16. What is a likely effect of a contractionary monetary policy?
17. What is the effect of increasing reserve requirements on banks?
18. Fill in the blank: The money multiplier is calculated as __________.
19. Which of the following statements is true?
20. Cause → Effect: A significant increase in money supply leads to _____ in aggregate demand.
21. True or False: Lowering the reserve requirement can help stimulate economic growth.
22. What might happen if too many depositors withdraw their funds at once?
23. What does the required reserve ratio (RRR) determine?
24. True or False: An increase in the money supply can lead to a decrease in interest rates.
25. What does quantitative easing primarily aim to achieve?
26. What are required reserves?
27. True or False: Increasing the reserve requirement directly increases the money supply.
28. What happens to consumer spending when the money supply is decreased?
29. Which scenario illustrates the impact of the Federal Reserve raising interest rates?
30. What effect do high reserve requirements have on lending?
31. What is the result of a liquidity trap?
32. Which of the following could result from a reduction in money supply?
33. What is the discount rate?
34. Which is NOT a consequence of low reserves?
35. Which of the following is NOT part of M2?
36. Which of the following scenarios illustrates the liquidity effect?
37. In the context of monetary policy, what does 'expansionary' refer to?
38. What is the difference between excess reserves and required reserves?
39. What is the primary function of the money supply?
40. What is the long-term effect of increasing money supply on real output?
41. What happens when the Fed sells government securities?
42. How does bank lending affect the money supply overall?
43. If banks loan out $100 with a reserve requirement of 10%, how much total money can theoretically be created?
44. Fill in the blank: A decrease in money supply generally leads to _____ in the economy.
45. Which of the following best describes a liquidity trap?
46. What is a bank's balance sheet?
47. How does an expansionary monetary policy generally affect economic activity?
48. True or False: Lowering the money supply can be a strategy to control inflation.
49. True or False: Raising the discount rate usually leads to more lending by banks.
50. True or False: Higher interest rates generally encourage more lending.
51. What does an increase in the money supply typically lead to?
52. What is the relationship between money supply and interest rates?
53. What is the relationship between interest rates and the money supply in contractionary policy?
54. Which term describes the ratio of reserves to deposits?
55. Which of the following best describes M2?
56. Which of the following is NOT an effect of an increase in money supply?
57. What is the main goal of contractionary monetary policy?
58. Why do banks engage in lending?
59. What is the effect of increasing the money supply on interest rates?
60. What impact does confidence have on the effectiveness of increased money supply?
61. What typically happens when the Federal Reserve lowers the discount rate?
62. Which of the following best describes the primary risk associated with fractional reserve banking?
63. Which of the following best describes the relationship between M1 and M2?
64. What is the likely short-term effect on unemployment when a central bank increases the money supply?
Related Study Sets
AS-AD-Modell Makroökonomie Prüfungsfragen
Solow-Wachstumsmodell Steady State Karteikarten
Klausur: Phillips-Kurve Inflation und Arbeitslosigkeit
Geldschöpfung der Geschäftsbanken Zusammenfassung
Keynesianismus und Monetarismus Karteikarten
Nachfrage Notizen
Staatshaushalt grob
Klausur: IS-LM-Modell Makroökonomie
Create Your Own Study Set
Upload a PDF, paste your notes, or describe a topic – AI generates flashcards, quizzes and more in seconds.
