Money and Banking
SAMPLE SECOND QUIZ
Answer all the questions. Include calculations and/or reasons with your answers wherever appropriate. More credit will be given for correct reasoning than for correct numbers.
1. Your friend Dave wants to open an ice cream stand. He knows the business, and you know him to be honest and generally hard working. He needs $50,000 but has only $3,000 or his own to invest. You are thinking of forming a syndicate of stockholders; each of the 20 of you would put up $2,350 to make up the other $47,000, and Dave would get a 10% share of the profits (as well as a reasonable salary for Dave).
(a) What agency (moral hazard) problems do you see in this arrangement?
(b) What steps could Dave and the syndicate take to minimize those problems?
2. Give sample abbreviated balance sheets for a commercial bank and for the Fed each with total assets (and liabilities plus net worth) of $100. Explain any symbols or abbreviations. Where do we see the monetary base?
3. What does a bank normally do when it wants more reserves? If that is not possible because the bank is rumored to be in danger of failing, what other means does it have of getting more reserves? Which of these means does it wish to avoid if at all possible and why?
4. What does the Fed do when it wants to increase the money supply? How does the entire process work, and what will happen if banks decide to keep substantially greater excess reserves than usual?
5. Explain why banks are inherently unstable. What is there about “making loans and taking deposits” that makes bank runs possible at almost any time without government back-up? How does the “lemons” problem help explain?
6. What will happen to the money supply when bank runs threaten to become contagious? What will happen to the money multipliers and why?