9.4 Money and Banking Quiz

Which of the following is NOT a primary function of money?

• Medium of exchange

• Store of value

• Unit of account

• Source of profit

Answer explanation

The primary functions of money are to serve as a medium of exchange, a store of value, and a unit of account. 'Source of profit' is not a function of money, making it the correct answer.

The term 'M1' in money supply usually refers to:

• The total of currency and demand deposits

• All currency in circulation, including time deposits

• Only long-term savings deposits

• Total reserves held by commercial banks

Answer explanation

The term 'M1' refers to the most liquid forms of money, which include physical currency and demand deposits. This makes 'The total of currency and demand deposits' the correct choice, as it accurately defines M1.

Central banks primarily use which tool to control inflation?

• Tax policy

• Government spending

• Monetary policy

• Trade tariffs

Answer explanation

Central banks primarily use monetary policy to control inflation by adjusting interest rates and regulating money supply, which directly influences economic activity and price levels.

The term 'fiat money' refers to money that:

• Has intrinsic value, like gold coins

• Is backed by precious metals

• Has no intrinsic value but is accepted by decree

• Is backed by foreign reserves

Answer explanation

The correct choice, 'Has no intrinsic value but is accepted by decree', defines fiat money, which derives its value from government regulation or law, rather than physical commodities like gold.

The main function of a central bank in regard to commercial banks is to:

• Lend to banks as a last resort

• Offer loans to private individuals

• Issue government bonds

• Set commercial banks' interest rates

Answer explanation

The central bank's primary role is to lend to commercial banks as a last resort, ensuring liquidity in the banking system. This function stabilizes the financial system, unlike the other options which are not central bank functions.

Which of the following would lead to an increase in the money supply in the economy?

• Central bank raises the reserve ratio

• Central bank purchases government bonds

• Central bank increases discount rates

• Commercial banks reduce lending

Answer explanation

The central bank purchasing government bonds injects money into the economy, increasing the money supply. The other options either restrict money supply or do not directly increase it.

In a fractional reserve banking system, commercial banks:

• Must keep 100% of deposits in reserve

• Lend out a portion of deposits while keeping a fraction as reserve

• Cannot lend money as deposits are used up

• Lend without keeping any reserves

Answer explanation

In a fractional reserve banking system, commercial banks lend out a portion of deposits while keeping a fraction as reserve. This allows them to create credit while ensuring liquidity for withdrawals.

Quantitative easing (QE) is a policy where the central bank:

• Increases government spending directly

• Lowers interest rates to increase borrowing

• Purchases long-term securities to increase money supply

• Restricts commercial banks' lending

Answer explanation

Quantitative easing (QE) involves the central bank purchasing long-term securities to inject liquidity into the economy, thereby increasing the money supply. This is distinct from directly increasing government spending or lowering interest rates.

The money multiplier effect explains how:

• banks create money through lending

• the central bank controls inflation

• interest rates are determined

• government spending affects the economy

Answer explanation

The money multiplier effect illustrates how banks can create money by lending out a portion of deposits. This process increases the overall money supply in the economy, making the correct choice 'banks create money through lending'.

Banks create money by issuing bonds. Each initial deposit leads to a multiple increase in the money supply. Government deficits multiply money supply. Foreign reserves impact the money supply.

• Banks create money by issuing bonds

• Each initial deposit leads to a multiple increase in the money supply

• Government deficits multiply money supply

• Foreign reserves impact the money supply

Answer explanation

The correct choice highlights that each initial deposit leads to a multiple increase in the money supply, reflecting the process of fractional reserve banking where banks lend out a portion of deposits, thus expanding the money supply.