Question 1

What are depository institutions?

Accepted Answer

Institutions that accept deposits from individuals and businesses, such as commercial banks

Question 2

What is a balance sheet?

Accepted Answer

A financial statement that shows the assets, liabilities, and equity of an institution at a given point in time

Question 3

What is fractional reserve banking?

Accepted Answer

A system in which depository institutions keep only a fraction of their deposits in reserve and lend out the rest

(the fraction they must keep is the required reserve)

Question 4

What are required reserves?

Accepted Answer

The minimum amount of reserves that a depository institution is required to hold by law

(opposite of excess reserves)

Question 5

What are excess reserves?

Accepted Answer

The reserves that a depository institution holds above and beyond the required reserves

Question 6

What is the reserve ratio?

Accepted Answer

The portion of deposits that a bank must hold onto

(everything else can be excess reserves)

Question 7

What is the money multiplier?

Accepted Answer

The ratio of the money supply to the monetary base

The amount of money that the banking system can generate with each dollar of excess reserves that it holds

Question 8

How do you calculate the money multiplier?

Accepted Answer

If the reserve ratio is 0.2, the money multiplier = 1/0.2 = 5

Question 9

How do banks create new money?

Accepted Answer

By making loans, which creates new deposits and expands the money supply

Question 10

Why might the amount predicted by the simple money multiplier be overstated?

Accepted Answer

It does not take into account a bank's desire to hold excess reserves or the public holding more currency

(both of these limit the amount of money banks can create)

4.4 Banking and the Expansion of the Money Supply, AP Macroeconomics Flashcards