Economic Issues and Credit Cards

BUS 535—Economic Issues, summer 2019
Discussion Questions Set 2
Question 1:
Credit cards affect the monetary system by reducing the demand for money in the short-
run, and in the long-run, the repayment of credit bank debt, increases the demand for
transactional money. However, it is widely believed that the increased use of credit cards will
reduce the money supply.
Question 2:
Banks play an important role in the transmission of the government’s monetary policy
aimed at achieving economic growth without inflation. Bank failures have great ramifications to
their customers, the community, other banks, and the nation as whole. When a bank fails,
customers cannot access their deposits or other services such as loan which creates money. To
avoid the great disruptions, nations tend to insure deposits in case of a bank failure, in addition to
highly regulating the banking sector.
Question 3:
a. When all money is held as currency, the money supply equals to the monetary base.
Monetary base = 1,000 * $1 = $1,000. Therefore, the money supply is $1,000.
b. When all the money is held as demand deposit, and the bank holds 100 percent of the
deposits as reserves, there are no loans disbursed. Therefore, the money supply = $1 *
1,000 = $1,000.
c. When all the money is held as demand deposit, and the bank holds 20% of the deposits as
reserves, then the reserve-deposit ratio is 20/100 = 0.20. The currency deposit ratio is
zero.
The money multiplier is: m = (cr+1)/ (cr+rr) = (0+1)/(0+0.20) = 1/0.20 = 5
Therefore, the money supply is equal to the monetary base times the money multiplier,
that is $1,000*5 = $5,000.
d. When people hole equal amounts of currency and demand depots, and banks hold 20% of
deposits as reserves, then the reserve-deposit ratio is 0.2, and the currency-deposit ratio is
1.
The money multiplier is: m = (cr+1)/ (cr+rr) = (1+1)/(1+0.20) = 2/1.20 = 1.667
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Therefore, the money supply is equal to the monetary base times the money multiplier,
that is $1,000*1.667 = $1,666.67.
e. The monetary base is proportional to the money supply, where the money supply, M =
Money multiplier, m X Monetary Base, B. If the m is a constant number, then a 10%
increase of the money supply by the central banks, should increase the monetary base by
10 percent. This is subject to the currency-deposit ratio and reserve-deposit ratio
remaining constant.
Question 4:
a. The check tax increased the currency-deposit ratio, cr. This is because people would be
reluctant to uses checking accounts as a means of exchange which will lead to a decrease
in deposits. The introduction of check tax would make checking accounts more expensive
for the citizens, hence people would prefer to use cash as a means of exchange. When
people hold more cash for transactional purposes, the currency-deposit ratio rises.
b. Under the fractional-reserve banking, the money supply, M1 = m*B, where the money
multiplier, m= cr +1
r +rr . With the checks being taxed, people decreased their use of
checking acconts and held more cash for transactions, then the cr =C /D increases;
therefore, the money multiplier decreases, which in turn decreases the money supply.
c. No, the check tax was not a good policy to implement in the middle of the Great
Depression. One, the check tax policy resulted to a decrease in the money supply, which
meant banks had less reserves to generate money from loans.
Question 5:
The balance sheet below is an example of a bank with a leverage ratio of 10; because the
total assets are $12,000 and capital is $1,200
Assets Liabilities and Owner’s Equity
Reserves $2,000 Deposits $8,000
Loans $6,000 Debt $2,800
Securitie
s
$4,000 Owner’s Equity $1,200
Total $12,000 Total $12,000
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