Page 308 - Krugmans Economics for AP Text Book_Neat

again and permitting a further round of loans, and so on, leading to a rise in the money
supply. An open -market sale has the reverse effect: bank reserves fall, requiring banks
to reduce their loans, leading to a fall in the money supply.
Economists often say, loosely, that the Fed controls the money supply—checkable
deposits plus currency in circulation. In fact, it controls only the monetary base—
bank reserves plus currency in circulation. But by increasing or reducing the mone-
tary base, the Fed can exert a powerful influence on both the money supply and
interest rates. This influence is the basis of monetary policy, discussed in detail in
Modules 28 and 29.

Module 27 AP Review

Solutions appear at the back of the book.
Check Your Understanding

1. Assume that any money lent by a bank is deposited back in the purchase of U.S. Treasury bills by the Fed on the value of
banking system as a checkable deposit and that the reserve ratio checkable bank deposits. What is the size of the money
is 10%. Trace out the effects of a $100 million open -market multiplier?

Tackle the Test: Multiple-Choice Questions
1. Which of the following is a function of the Federal Reserve 3. When the Fed makes a loan to a commercial bank, it charges
System? a. no interest.
I. examine commercial banks b. the prime rate.
II. print Federal Reserve notes c. the federal funds rate.
III. conduct monetary policy d. the discount rate.
a. I only e. the market interest rate.
b. II only
4. If the Fed purchases U.S. Treasury bills from a commercial
c. III only
bank, what happens to bank reserves and the money supply?
d. I and III only
Bank reserves Money supply
e. I, II, and III
a. increase decrease
2. Which of the following financial services does the Federal b. increase increase
Reserve provide for commercial banks? c. decrease decrease
I. clearing checks d. decrease increase
II. holding reserves e. increase no change
III. making loans
5. When banks make loans to each other, they charge the
a. I only
a. prime rate.
b. II only
b. discount rate.
c. III only
c. federal funds rate.
d. I and II
d. CD rate.
e. I, II, and III
e. mortgage rate.

266 section 5 The Financial Sector