Chapter 20 : Money Supply and Money Demand

1. Which of the following is/are included in money supply?

(1) coins in public circulation
(2) banknotes in public circulation
(3) bank deposits
A. (2) only
B. (3) only
C. (1) and (2) only
D. (1), (2) and (3)

2. Money supply M1 includes _______________.

(1) demand deposits with licensed banks
(2) savings deposits with licensed banks
(3) currency held by the public
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)

3. Banknotes held by banks _______________ in money supply M1, because _______________.

A. is included … their value is rather stable
B. is included … the liquidity of these banknotes is very high
C. is not included … these banknotes are not used as a medium of exchange
D. is not included … they cannot fulfil the function of money as a store of value

4. In Hong Kong, _______________ is the narrowest definition of money supply.

A. money supply M1
B. money supply M2
C. money supply M3
D. None of the above.

5. Which of the following about money supply M1 is CORRECT?

A. Time deposits are included in M1.
B. M1 is the broadest definition of money supply.
C. Negotiable certificates of deposit are included in M1.
D. M1 consists of non-interest-bearing components only.

6. Money supply M2 emphasises the function of money as a _______________.

A. medium of exchange
B. store of value
C. unit of account
D. standard of deferred payment
7. Which of the following are included in money supply M2?
(1) currency held by the public
(2) demand deposits with licensed banks
(3) time deposits with licensed banks
(4) time deposits with deposit-taking companies
A. (1) and (2) only
B. (3) and (4) only
C. (1), (2) and (3) only
D. (2), (3) and (4) only

8. Which of the following statements about money supply M2 is/are INCORRECT?

(1) Money supply M2 has broader coverage than money supply M1.
(2) Money supply M2 includes all the components of money supply M3.
(3) Negotiable certificates of deposit issued by deposit-taking companies are included in money
supply M2.
(4) Demand deposits are included in money supply M2.
A. (2) only
B. (1) and (4) only
C. (2) and (3) only
D. (2), (3) and (4) only

9. Study the following table.

$ billion
Currency held by the public 2
Demand deposits 5
Deposits with licensed banks 12
Deposits with restricted licence banks and
20
deposit-taking companies
Negotiable certificates of deposit issued
by licensed banks, restricted licence 18
banks and deposit-taking companies
The money supply M2 of this economy is
A. $7 billion.
B. $19 billion.
C. $57 billion.
D. indeterminate.
10. Negotiable certificates of deposit issued by _______________ are included in money supply M3.
(1) licensed banks
(2) restricted licence banks
(3) deposit-taking companies
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)

11. _______________ consist(s) of both interest-bearing components and non-interest-bearing components.

(1) M1
(2) M2
(3) M3
A. (1) only
B. (3) only
C. (1) and (2) only
D. (2) and (3) only

12. Peter transfers $30,000 from his time deposit account in a licensed bank to his current account in the
same bank. What will be the immediate effect on money supply M1 and M2 of Hong Kong?
A. Both money supply M1 and M2 decrease.
B. Both money supply M1 and M2 increase.
C. Money supply M1 remains unchanged while money supply M2 decreases.
D. Money supply M1 increases while money supply M2 remains unchanged.

13. Mrs. Lee withdraws a $5,000 deposit from a deposit-taking company and keeps it as cash. What will be
the immediate effect on money supply M1 and M3 of Hong Kong?
A. Both money supply M1 and M3 increases.
B. Both money supply M1 and M3 decrease.
C. Money supply M1 increases while money supply M3 remains unchanged.
D. Money supply M1 remains unchanged while money supply M3 decreases.

14. Which of the following events will lead to a change in money supply M1?
A. Jenny deposits a certain amount of cash into her current account.
B. Lily uses the cash in hand to buy a negotiable certificate of deposit issued by a licensed bank.
C. Mary buys a car by cheque and the seller deposits the amount into his current account.
D. Danny withdraws a certain amount of money from his time deposit account with a licensed bank
and uses it to buy a negotiable certificate of deposit issued by a deposit-taking company.
15. Suppose people prefer holding more assets in the form of negotiable certificates of deposit and fewer
assets in the form of cash. This MUST lead to a fall in money supply
A. M1.
B. M2.
C. M2 and M3.
D. M1, M2 and M3.

16. Suppose Mr. Wong withdraws $80,000 from his time deposit account in a licensed bank. He remits
$50,000 to his mother in the US and deposits the remaining money into a restricted licence bank. As a result,
money supply M1 _______________, M2 _______________ and M3 _______________.
A. remains unchanged … decreases … decreases
B. remains unchanged … decreases … increases
C. decreases … decreases … decreases
D. increases … remains unchanged … remains unchanged

17. Jane remits $4,000 cash in hand to Japan. What is the immediate effect of Jane’s action on the money
supply of Hong Kong?
A. Money supply M1, M2 and M3 remain unchanged.
B. Money supply M1, M2 and M3 decrease.
C. Money supply M1 and M2 decrease while money supply M3 remains unchanged.
D. Money supply M1 decreases while money supply M2 and M3 remain unchanged.

18. Suppose Bank XYZ has $500,000 of deposit and the minimum reserve ratio is 10%. The actual reserves
held by Bank XYZ are $80,000. The actual reserve ratio is _______________ and the amount of excess
reserves is _______________.
A. 10% … $30,000
B. 10% … $80,000
C. 16% … $30,000
D. 16% … $80,000

19. If there are excess reserves in the banking system, which of the following is/are CORRECT?
(1) The actual reserves in the banking system are larger than the required reserves.
(2) The actual reserve ratio is larger than the required reserve ratio.
(3) The actual banking multiplier is greater than the maximum banking multiplier.
A. (1) only
B. (3) only
C. (1) and (2) only
D. (1), (2) and (3)
20. Suppose the total deposits in Bank ABC are $100,000. The actual reserves are $30,000 and there are
excess reserves of $5,000. The maximum banking multiplier is _______________.
A. 5
B. 20
C. 3.33
D. 4

21. Ben withdraws $3,000 from his current account in Bank ABC and deposits this sum of money into his
savings account in Bank XYZ. If the required reserve ratio is 15%, the maximum possible amount of
deposits will increase by
A. $0.
B. $3,000.
C. $20,000.
D. There is insufficient information to determine the answer.

22. The following table shows the balance sheet of a banking system. No banks hold excess reserves.
Assets ($) Liabilities ($)
Reserves 250 Deposits 1,000
Loans 750
Suppose a customer withdraws $100 from a bank. The immediate effect(s) on the banking system is/are
(1) a shortage of reserve of $100.
(2) a decrease in reserves by $100.
(3) a decrease in deposits by $400.
A. (2) only
B. (1) and (2) only
C. (2) and (3) only
D. (1), (2) and (3)

23. The following table shows the balance sheet of a banking system.
Assets ($) Liabilities ($)
Reserves 300 Deposits 1,200
Loans 900
Assume the legal reserve ratio is 15%. Which of the following statements is INCORRECT?
A. The required reserves are $180.
B. The actual banking multiplier is 6.67.
C. There are excess reserves of $120.
D. The actual reserve ratio is 25%.
For questions 24 and 25, refer to the following information. The following table shows the balance sheet of a
banking system. The banking system is fully loaned up. The public always hold 500 cash.
Assets ($) Liabilities ($)
Reserves 1,000 Deposits 5,000
Loans 4,000
24. The money supply of this economy is
A. $5,000.
B. $5,500.
C. $6,000.
D. $27,500.

25. Suppose $600 of banknotes are issued by the government. The maximum amount of deposits in the
banking system is
A. $5,600.
B. $7,000.
C. $7,700.
D. $8,000.

26. Assume the required reserve ratio is 25%. If Bank ABC has deposits of $200,000 and its actual reserves
are three times of its required reserves, the excess reserves are _______________.
A. $0
B. $50,000
C. $100,000
D. $150,000

27. The following table shows the balance sheet of Bank ABC.
Assets ($) Liabilities ($)
Reserves 600 Deposits 2,000
Loans and investments 1,400
If the excess reserves are $150, which of the following is CORRECT?
A. The required reserves are $400.
B. The actual reserve ratio is smaller than the required reserve ratio.
C. The maximum banking multiplier is 4.44.
D. The actual reserve ratio is 33%.
28. The following table shows the balance sheet of a banking system. There are excess reserves of $100.

Assets ($) Liabilities ($)

Reserves 300 Deposits 1,500
Loans and investments 1,200
The minimum reserve ratio is _______________ and the actual reserve ratio is _______________.
A. 6.7% … 13.33%
B. 6.7% … 20%
C. 13.33% … 20%
D. 20% … 13.33%

29. The following table shows the balance sheet of a bank. The minimum reserve ratio of the banking
system is 20%.

Assets ($) Liabilities ($)

Reserves 450 Deposits 1,800
Loans and investments 1,350
If the bank lends out all the excess reserves, the amount of deposits after credit creation process is
_______________.
A. $1,800
B. $1,900
C. $2,160
D. $2,250

30. Suppose someone deposits $500 cash into his savings account but the bank cannot make any new loans.
Money supply will _______________.
A. increase
B. decrease
C. remain unchanged
D. increase or decrease

31. The following table shows the balance sheet of a banking system.
Assets ($) Liabilities ($)
Reserves 700 Deposits 2,000
Loans and investments 1,300
Suppose there are excess reserves of $500. Which of the following statements is CORRECT?
A. The actual banking multiplier is 10.
B. The required reserve ratio is 35%.
C. The maximum possible amount of deposits created is $7,000.
D. The actual reserve ratio is 10%.
32. The following table shows the balance sheet of a banking system. The required reserve ratio is 25%.
Assets ($) Liabilities ($)
Cash reserves 800 Deposits 3,000
Loans 2,200
Suppose the banks lend out all excess reserves. The maximum possible amount of deposits and loans are
_______________ and _______________ respectively.
A. $50 … $2,200
B. $200 … $2,800
C. $2,400 … $3,200
D. $3,200 … $2,400

33. Money supply will increase if

A. banks decide to hold more reserves.
B. the central bank raises the minimum reserve ratio.
C. more new coins are issued by the central bank.
D. All of the above.

34. Miss Leung received $10,000 from her father in England and she deposited this money into a bank in
Hong Kong. If the required reserve ratio is 20%, the maximum increase in Hong Kong’s money supply is
A. $10,000.
B. $40,000.
C. $50,000.
D. $60,000.

35. When the _______________ increases, the maximum banking multiplier will decrease.
A. total amount of deposits
B. currency held by public
C. demand for loans
D. minimum reserve ratio

36. In reality, the actual amount of deposits created in a banking system is always less than the maximum
possible amount created. Which of the following is/are the main reason(s)?
(1) Banks cannot lend out all their excess reserves.
(2) Banks keep reserves at a level higher than that required by the government for safety reasons.
(3) The public keeps some of the loans as cash to deal with daily transactions.
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)
37. Which of the following is/are the necessary condition(s) for deposit creation to take place?
(1) There is no cash leakage.
(2) The required reserve ratio is less than 100%.
(3) Banks do not have excess reserves.
(4) There is demand for loans.
A. (4) only
B. (1) and (3) only
C. (2) and (4) only
D. (1), (2) and (4) only

38. Which of the following statements about “monetary base” is INCORRECT?

A. Monetary base is also called high-powered money.
B. Monetary base is always smaller than money supply.
C. Monetary base decreases if someone remits money to a foreign country.
D. Monetary base is the total amount of currency issued by the central bank.

39. Which of the following statements about high-powered money (M0) is/are CORRECT?
(1) It is the sum of currency in public circulation and reserves in the banking system.
(2) It must be smaller than M1.
(3) It is the total amount of currency issued by the central bank.
A. (1) only
B. (1) and (2) only
C. (1) and (3) only
D. (2) and (3) only

40. Suppose all the banks in an economy are fully loaned up. If the required reserve ratio in the banking
system is smaller than 100%, which of the following is/are CORRECT?
(1) The maximum banking multiplier is greater than 1.
(2) The money multiplier is greater than 1.
(3) The economy is using a fractional reserve system.
A. (1) only
B. (1) and (2) only
C. (2) and (3) only
D. (1), (2) and (3)

41. If the required reserve ratio of a banking system is 100%, which of the following statements is
INCORRECT?
A. The excess reserves are always zero.
B. When someone deposits $10,000 cash into his or her current account, the money supply remains
unchanged.
C. The maximum banking multiplier is 1.
D. The monetary base of the economy is smaller than the money supply.
42. Without deposit creation, when a local resident deposits some cash into a bank, the amount of
_______________ increases while the amount of _______________ remains unchanged.
A. bank deposits … money supply
B. bank deposits … bank reserves
C. monetary base … deposits
D. money supply … deposits

43. In a banking system, total deposits reach the maximum possible amount by credit creation. Which of the
following must be CORRECT?
(1) The actual banking multiplier is equal to the maximum banking multiplier.
(2) The reserve deposit ratio is equal to the required reserve ratio.
(3) The money supply is equal to the monetary base.
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)

44. When the nominal interest rate decreases, _______________ for money increases and people will hold
_______________ money.
A. transaction demand … more
B. transaction demand … less
C. asset demand … more
D. asset demand … less

45. Which of the following about money demand is/are CORRECT?

(1) The money demand curve shows the relationship between the quantity of money demanded and
the nominal interest rate, assuming all other factors affecting the amount of money that people
wish to hold remain the same.
(2) The money demand curve is upward-sloping.
(3) Any change in the nominal interest rate will lead to a movement along the money demand curve.
A. (3) only
B. (1) and (2) only
C. (1) and (3) only
D. None of the above.

46. When nominal income increases, _______________ will increase; when the nominal interest rate
increases, _______________ will decrease.
A. total demand for money … total demand for money
B. total demand for money … total quantity demanded for money
C. total quantity demanded for money … total demand for money
D. total quantity demanded for money … total quantity demanded for money
47. If people expect bond prices to increase, _______________ will _______________.
A. transaction demand for money … increase
B. transaction demand for money … decrease
C. asset demand for money … increase
D. asset demand for money … decrease

48. Which of the following will cause the demand for money in Country Y to increase?
(1) a fall in nominal interest rate
(2) a rise in the nominal income of people
(3) an expectation of a fall in nominal interest rate
A. (2) only
B. (1) and (2) only
C. (2) and (3) only
D. (1), (2) and (3)

49. When the nominal interest rate of a country increases, _______________ will decrease.
(1) the level of planned investment
(2) the level of national income
(3) the value of domestic currency in terms of foreign currency
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)

50. Assume the interest rate of Country A increases while the interest rates of other countries remain
constant. There will be an _______________ Country A, and the exchange rates of Country A’s currency to
other currencies will _______________.
A. inflow of capital to … increase
B. inflow of capital to … decrease
C. outflow of capital from … increase
D. outflow of capital from … decrease

51. If more people use Octopus Cards to deal with daily transactions,
A. the money supply curve will shift to the right.
B. the money demand curve will shift to the left.
C. the nominal interest rate will increase.
D. None of the above.
52. Suppose the demand for money decreases. If the central bank wants to stabilise the nominal interest rate,
it can _______________ the required reserve ratio so as to _______________ money supply.
A. raise … increase
B. raise … decrease
C. lower … increase
D. lower … decrease

53. When money demand decreases, the equilibrium interest rate will _______________ and the
consumption expenditure will _______________.
A. decrease … decrease
B. decrease … increase
C. increase … increase
D. increase … decrease

54. Study the table below.

Asset demand for Transaction demand Money supply Nominal interest
money ($) for money ($) ($) rate (%)
200 700 1,200 15
300 700 1,200 13
400 700 1,200 11
500 700 1,200 9
600 700 1,200 7
What is the equilibrium interest rate?
A. 7%
B. 9%
C. 11%
D. 13%

55. Which of the following events would cause the money supply M1 to remain unchanged but the money
supply M3 to increase?
A. Miss Chow withdraws $2,000 from her demand deposits and keeps it as cash.
B. Miss Yu transfers $2,000 from her demand deposits to savings deposits with a licensed bank.
C. Miss Lee receives $2,000 cash from overseas and deposits it in a restricted licence bank.
D. Miss So uses $2,000 cash in hand to buy a negotiable certificate of deposit issued by a licensed
bank.

56. Which of the following is an effect of lowering the legal reserve requirement for banks?
A. The deposit creating ability of the banking system will increase.
B. The use of credit cards will become more popular.
C. The cash held by the public will decrease.
D. The demand for loans will increase.
57. Which of the following can explain the shift of the money demand curve from Md0 to Md1?

A. The nominal interest rate increases.

B. Household’s real income decreases.
C. More people use electronic money.
D. The price level increases.

58. Which of the following are included in the money supply M2?
(1) negotiable certificates of deposit issued by licensed banks held outside the banking sector
(2) legal tender notes and coins held by licensed banks
(3) customers’ demand deposits with licensed banks
(4) customers’ time deposits with licensed banks
A. (2) and (3) only
B. (1), (2) and (3) only
C. (1), (3) and (4) only
D. (2), (3) and (4) only

59. Suppose the money supply data of Hong Kong is as follows:

$ million
Legal tender held by commercial banks 20
Legal tender held by the public 30
Customers’ demand deposits with licensed banks 10
Customers’ savings and time deposits with licensed banks 5
Customers’ time deposits with restricted licence banks and deposit- 8
taking companies
Negotiable certificates of deposit issued by licensed banks held 3
outside the banking sector
Negotiable certificates of deposit issued by restricted licence banks 5
and deposit-taking companies held outside the banking sector
The money supply M2 and M3 are __________ and __________ respectively.
A. $48 million … $53 million
B. $48 million … $61 million
C. $68 million … $53 million
D. $68 million … $61 million
60. Mrs. Tang receives a cheque for HK$550,000 from her daughter. She puts HK$500,000 into her time
deposit account with a restricted licence bank and keeps the remainder in cash. Which of the following about
the immediate effect of the above actions on the Hong Kong dollar money supply is CORRECT?
(1) M1 will decrease.
(2) M2 will decrease.
(3) M3 will decrease.
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)

61. Anthony withdraws HK$200,000 from his current account. He remits HK$100,000 to the United States.
Then he puts the remainder into his time deposit account with a licensed bank.
Which of the following about the immediate effect of the above actions on the Hong Kong dollar money
supply is CORRECT?
A. M1, M2 and M3 will decrease by HK$100,000.
B. Both M1 and M2 will decrease by HK$200,000.
C. M2 will decrease by HK$100,000 and M3 will remain unchanged.
D. Both M2 and M3 will decrease by HK$100,000.

62. Refer to the following balance sheet of a banking system which has excess reserves of $100. The public
hold $100 cash.
Assets ($) Liabilities ($)
Reserves 300 Deposits 1,000
Loans 700
Suppose someone withdraws $100 from the banking system and holds in cash. How will the money supply
change if the banks lend out all excess reserves afterwards?
A. increase
B. decrease
C. remain unchanged
D. uncertain

63. Suppose the actual reserves of a banking system are $25 while $5 of the amount are the excess reserves.
The required reserve ratio is 20%. The public hold $50 cash. Which of the following statements about the
banking system are CORRECT?
(1) The actual reserve ratio is 25%.
(2) If the banks no longer hold excess reserves, the maximum possible amount of deposits is $100.
(3) The money supply of the economy is $150.
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)
64. Suppose a banking system does not hold any excess reserves. Raising the required reserve ratio will lead
to a decrease in
(1) the maximum banking multiplier.
(2) the money supply.
(3) the deposit creation ability of the banking system.
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)

65. Refer to the following information about an economy.

Money supply $2,200
Cash in public circulation $200
Required reserve ratio 25%
Suppose the banks do not hold any excess reserves. The monetary base of the economy will be
___________.
A. $500
B. $700
C. $800
D. $2,500

66. Refer to the following balance sheet of a banking system. The banks have $50 million excess reserves
and the public hold $100 million cash.
Assets ($ million) Liabilities ($ million)
Reserves 150 Deposits 500
Loans 350
If all banks loan out their excess reserves, which of the following statements about the banking system is
CORRECT?
(1) The monetary base will remain unchanged.
(2) The maximum banking multiplier will increase.
(3) The money supply will increase.
(4) The amount of loans that the banks lend out will increase.
A. (2) and (4) only
B. (1), (2) and (3) only
C. (1), (3) and (4) only
D. All of the above are correct.

67. Which of the following assets has the highest liquidity?

A. negotiable certificates of deposit
B. time deposits
C. demand deposits
D. bonds
68. When the nominal interest rate increases, the cost of holding money will ___________ and the
________________________ will decrease.
A. increase … asset demand for money
B. decrease … asset demand for money
C. increase … transaction demand for money
D. decrease … transaction demand for money

69. Which of the following will lead to a leftward shift of the money demand curve?
A. People expect a lower inflation rate in the future.
B. The time interval between income payments decreases.
C. The consumer price index continues an upward trend.
D. People’s wealth increases.

70. Which of the following will affect the transaction demand for money of an economy?
(1) People’s nominal income increases.
(2) Returns from holding other interest-bearing assets increase.
(3) People’s wealth increases.
A. (1) only
B. (3) only
C. (1) and (3) only
D. (2) and (3) only

71. Which of the following would lead to an increase in nominal interest rate?
(1) There is more extensive use of credit cards.
(2) The risk of holding other interest-bearing assets increases.
(3) The central bank raises the required reserve ratio.
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)
ANSWER KEY
1. D
Money supply includes cash (banknotes and coins) in public circulation and bank deposits.
2. B
M1 = Currency held by the public + Demand deposits with licensed banks
Savings deposits with licensed banks are included in M2 and M3 but not M1.
3. C
M1 = Currency held by the public + Demand deposits with licensed banks
M1 emphasises the function of money as the medium of exchange. Banknotes held by banks are not used as
a medium of exchange.
4. A
M1 = Currency held by the public + Demand deposits with licensed banks
M2 = M1 + Savings deposits and time deposits with licensed banks + Negotiable certificates of deposit
issued by licensed banks held outside the banking sector
M3 = M2 + Deposits with restricted licence banks and deposit-taking companies + Negotiable certificates of
deposit issued by restricted licence banks and deposit-taking companies held outside the banking
sector
M1 is the narrowest definition of money supply in Hong Kong, as both M2 and M3 consist of the
components of M1.
5. D
M1 = Currency held by the public + Demand deposits with licensed banks
Both the currency held by the public and demand deposits with licensed banks do not bear interest.
Option A is incorrect. Time deposits with licensed banks are included in both M2 and M3. Time deposits
with restricted licence banks and deposit-taking companies are included in M3.
Option B is incorrect. M1 is the narrowest definition of money supply.
Option C is incorrect. Negotiable certificates of deposit issued by licensed banks held outside the banking
sector are included in both M2 and M3. Negotiable certificates of deposit issued by restricted licence banks
and deposit-taking companies held outside the banking sector are included in M3.
6. B
M2 includes those components in M1, savings deposits and time deposits with licensed banks and negotiable
certificates of deposit (NCDs) issued by licensed banks held outside the banking sector. These deposits and
NCDs cannot settle payments immediately. They can function as a store of value but not a medium of
exchange.
7. C
M2 = M1 (Currency held by the public + Demand deposits with licensed banks) + Saving deposits and time
deposits with licensed banks + Negotiable certificates of deposit issued by licensed banks held outside the
banking sector
Currency held by the public, demand deposits and time deposits with licensed banks are included in M2.
Time deposits with deposit-taking companies are included in M3 only.
8. C
(2) is incorrect. M3 has a broader coverage than M2.
(3) is incorrect. Negotiable certificates of deposit issued by deposit-taking companies are included in M3,
but not in M2.
9. D
M2 = M1 (Currency held by the public + Demand deposits with licensed banks) + Saving deposits and time
deposits with licensed banks + Negotiable certificates of deposit issued by licensed banks held outside the
banking sector
As we cannot get the figure of negotiable certificates of deposit issued only by licensed banks, we cannot
determine the figure of M2.
10. D
M3 = M2 + Deposits with restricted licence banks and deposit-taking companies + Negotiable certificates of
deposit issued by restricted licence banks and deposit-taking companies held outside the banking sector
Since the negotiable certificates of deposit issued by licensed banks are included in M2, they are also
included in M3.
Therefore, negotiable certificates of deposit issued by licensed banks, restricted licence banks and deposit-
taking companies are included in M3.
11. D
(1) is incorrect. M1 consists of non-interest-bearing components only.
12. D
M1 M2
Peter withdraws $30,000 from his time
+$30,000
deposit account in a licensed bank
He transfers $30,000 to his current
-----
account in the same bank
Net change +$30,000 0
M1 increases while M2 remains unchanged.
13. C
M1 = Currency held by the public + Demand deposits with licensed banks
As currency held by the public increases by $5,000 while the amount of demand deposits with licensed
banks remains unchanged, M1 increases by $5,000.
Deposits with a deposit-taking company are included in M3. When Mrs. Lee withdraws a $5,000 deposit
from a deposit-taking company, M3 decreases by $5,000. Since M1 increases by $5,000, M3 remains
unchanged.
14. B
M1 = Currency held by the public + Demand deposits with licensed banks
When Lily uses the cash in hand to buy a negotiable certificate of deposit issued by a licensed bank,
currency held by the public will decrease while demand deposits with licensed banks will remain
unchanged. Therefore, M1 will decrease.
15. A
M1 = Currency held by the public + Demand deposits with licensed banks
Since currency held by the public decreases while demand deposits with licensed banks remain unchanged,
M1 must decrease.
As we do not know whether the negotiable certificates of deposit are issued by licensed banks, restricted
licence banks or deposit-taking companies, M2 may not decrease.
M3 includes M1 and the negotiable certificates of deposit are issued by licensed banks, restricted licence
banks and deposit-taking companies. Therefore, the effect caused by holding more negotiable certificates of
deposit on M3 is offset by holding less cash. M3 remains unchanged.
16. A
M1 M2 M3
Mr. Wong withdraws $80,000 from +$80,000 ---- ----
his time deposit account in a
licensed bank
He remits $50,000 to his mother in -$50,000 -$50,000 -$50,000
the US
He deposits the remaining $30,000 -$30,000 -$30,000 ----
into a restricted licence bank
Net change 0 -$80,000 -$50,000
M1 remains unchanged while M2 and M3 decrease.
17. B
The $4,000 remittance is no longer included in the money supply of Hong Kong. Therefore, M1, M2 and
M3 decrease by $4,000.
18. C
Actual reserve ratio = Actual reserves / Total deposits = $80,000 / $500,000 = 16%
Excess reserves = Actual reserves – Required reserves = $80,000 – $50,000 = $30,000
19. C
(1) is correct.
Excess reserves = Actual reserves – Required reserves
As there are excess reserves, the actual reserves in the banking system are larger than the required reserves.
(2) is correct.
Actual reserve ratio = Actual reserves / Total deposits
Required reserve ratio = Required reserves / Total deposits
As the actual reserves are larger than the required reserves, the actual reserve ratio is thus larger than the
required reserve ratio.
(3) is incorrect. Actual banking multiplier = 1 / actual reserve ratio, while maximum banking multiplier = 1 /
required reserve ratio. As the actual reserve ratio is larger than the required reserve ratio, the actual banking
multiplier is smaller than the maximum banking multiplier.
20. D
Required reserves = Actual reserves – Excess reserves = $30,000 – $5,000 = $25,000
Required reserve ratio = Required reserves / Total deposits = $25,000 / $100,000 = 25%
Maximum banking multiplier = 1 / Required reserve ratio = 1 / 25% = 4
21. A
Money creation resulting from the increase in deposits in Bank XYZ will be offset by money contraction
brought by the withdrawal of deposits in Bank ABC by the same amount. The maximum possible amount of
deposits will not increase.
22. A
After the withdrawal, the balance sheet is as below:
 Assets ($) Liabilities ($)
Reserves 150 Deposits 900
Loans 750
(2) is correct. The amount of reserves decreases from $250 to $150.
(1) is incorrect. As there are no excess reserves in the banking system, required reserve ratio = $250 / $1,000
= 25%.
When the amount of deposits is $900, required reserves = $900  25% = $225
There is a shortage of reserves of $75 ($225 – $150).
(3) is incorrect. The amount of deposits decreases by $100 ($1,000 – $900).
23. B
Actual reserve ratio = Actual reserves / Total deposits = $300 / $1,200 = 25%
Actual banking multiplier = 1 / Actual reserve ratio = 1 / 25% = 4
Option A is correct. Required reserves = Total deposits  Required reserve ratio = $1,200  15% = $180
Option C is correct. Excess reserves = Actual reserves – Required reserve = $300 – $180 = $120
24. B
Money supply = Cash in public circulation + Bank deposits
= $500 + $5,000
= $5,500
25. D
As the banking system is fully loaned up, required reserve ratio = $1,000 / $5,000 = 20%.
The maximum increase in deposits = Amount of bank notes issued / Required reserve ratio
= $600 / 20%
= $3,000
Therefore, the maximum amount of deposits in the banking system
= $5,000 + $3,000
= $8,000
26. C
Required reserves = Total deposits  Required reserve ratio = $200,000  25% = $50,000
Actual reserves = $50,000  3 = $150,000
Excess reserves = Actual reserves – Required reserves = $150,000 – $50,000 = $100,000
27. C
Required reserve ratio = (Actual reserves – Excess reserves) / Total deposits
= ($600 – $150) / $2,000 = 22.5%
Maximum banking multiplier = 1 / Required reserve ratio = 1 / 22.5% = 4.44
Option A is incorrect. Required reserves = Actual reserves – Excess reserves = $600 – $150 = $450.
Option B and D are incorrect. Actual reserve ratio = Actual reserves / Total deposits = $600 / $2,000
= 30%.
28. C
Minimum reserve ratio = (Actual reserves – Excess reserves) / Total deposits
= ($300 – $100) / $1,500 = 13.33%
Actual reserve ratio = Actual reserves / Total deposits = $300 / $1,500 = 20%
29. D
The amount of deposits after credit creation process = $450  (1 / 0.2) = $2,250
30. C
Money supply = Cash in public circulation + Bank deposits
Cash in public circulation falls by $500. As the bank cannot make any new loans from this sum of money,
this sum of money becomes the excess reserves of the bank. Bank deposits increases by $500. Money supply
will thus remain unchanged.
31. C
Required reserve ratio = ($700 – $500) / $2,000 = 10%
Maximum possible amount of deposits created = $700 / 10% = $7,000
32. D
Maximum possible amount of deposits = $800 × (1 / 25%) = $3,200
Maximum possible amount of loans = [$800 × (1 – 25%)] / (1 / 25%)
= $2,400
33. C
Money supply = Cash in public circulation + Bank deposits
If more coins are issued by the central bank, cash in public circulation will increase. Money supply will
increase.
Option A is incorrect. If banks decide to hold more reserves, the maximum amount of deposits created in the
banking system will decrease. Money supply will decrease.
Option B is incorrect. When the central bank raises the minimum reserve ratio, reserves that banks can loan
out will decrease. Bank deposits will decrease and money supply will decrease.
34. C
Money supply = Cash in public circulation + Bank deposits
Maximum increase in money supply
= $0 (no change in cash in public circulation) + $10,000  (1 / 20%) (maximum possible amount of deposits
created)
= $50,000
35. D
Maximum banking multiplier = 1 / Minimum reserve ratio
When the minimum reserve ratio increases, the maximum banking multiplier will decrease.
36. D
Both (1) and (2) are correct. If banks cannot lend out all their excess reserves or they keep reserves at a level
higher than that required by the government for safety reasons, banks have excess reserves. The actual
amount of deposits created will be smaller than the maximum possible amount.
(3) is correct. If the public keeps some of the loans as cash to deal with daily transactions, the amount of
deposits created will become smaller.
37. C
(2) is correct. If the required reserve ratio is 100%, banks will not have excess reserves to lend out. New
money cannot be created.
(4) is correct. If there is no demand for loans, no one will borrow from banks. Banks can only keep deposits
as reserves. The banking system cannot create any new money.
(1) and (3) are incorrect. If there is cash leakage or banks have excess reserves, the banking system cannot
create the maximum possible amount of money; some new money can still be created though.
38. B
Monetary base = Currency in public circulation + Bank reserves
Money supply = Cash in public circulation + Bank deposits
If the required reserve ratio is 100%, bank reserves will be equal to bank deposits and monetary base will be
equal to money supply.
39. C
(2) is incorrect.
M0 = Currency in public circulation + Bank reserves
M1 = Currency held by the public + Demand deposits with licensed banks
There is no direct relationship between M0 and M1. M0 can be smaller than, equal to or greater than M1.
40. D
(1) is correct.
Maximum banking multiplier = 1 / Required reserve ratio
As the required reserve ratio is smaller than 100%, the maximum banking multiplier is greater than 1.
(2) is correct.
Money multiplier = Money supply / Monetary base
As the required reserve ratio is smaller than 100%, the process of credit creation allows the money supply of
an economy to be greater than its monetary base.
(3) is correct. Fractional reserve system means the banks only have to keep a fraction of deposits as reserve.
41. D
Money supply = Cash in public circulation + Bank deposits
Monetary base = Currency in public circulation + Bank reserves
If the required reserve ratio is 100%, the maximum banking multiplier is 1. Bank deposits are equal to bank
reserves. The monetary base of the economy is equal to the money supply.
Option A is correct. All bank reserves are required reserves, so there will be no excess reserves in the
banking system.
Option B is correct. When someone deposits $10,000 into his or her current account, cash in public
circulation decreases by $10,000 while bank deposits increase by $10,000. The money supply remains
unchanged.
Option C is correct. Maximum banking multiplier = 1 / Required reserve ratio = 1 / 100% = 1
42. A
Money supply = Cash in public circulation + Bank deposits
Without deposit creation, the decrease in cash in public circulation is equal to the increase in bank deposits.
Money supply remains unchanged.
Option B is incorrect. Bank reserves will increase by the amount of deposits.
Option C is incorrect. Monetary base = Currency in public circulation + Bank reserves
Without deposit creation, the decrease in currency in public circulation is equal to the increase in bank
reserves. Monetary base remains unchanged.
43. A
Actual banking multiplier = 1 / Actual reserve ratio
Maximum banking multiplier = 1 / Required reserve ratio
If total deposits reach the maximum possible amount, the actual reserves will be equal to the required
reserves. The actual reserve ratio (i.e. the reserve deposit ratio) will be equal to the required reserve ratio.
The actual banking multiplier will also be equal to the maximum banking multiplier.
(3) is incorrect. Money supply = cash in public circulation + bank deposits, while monetary base = currency
in public circulation + bank reserves. Total deposits reaching the maximum possible amount does not imply
that the bank deposits and the bank reserves are equal.
44. C
When the nominal interest rate decreases, asset demand for money increases while transaction demand for
money is not affected.
The nominal interest rate is the opportunity cost of holding money. When the nominal interest rate
decreases, the opportunity cost of holding money decreases and people will hold more money.
45. C
(2) is incorrect. As demand for money is negatively related to the nominal interest rate, the money demand
curve is downward-sloping.
46. B
When there is an increase in nominal income, people will consume more goods and services. As there are
more transactions to be made, total demand for money will increase.
When the nominal interest rate increases, asset demand for money decreases while transaction demand for
money is not affected. Thus, the total quantity demanded for money will decrease.
47. D
When people expect bond prices to increase, they will choose to hold more bonds and less money as assets.
Asset demand for money will therefore decrease.
48. A
(1) is incorrect. A change in the nominal interest rate will lead to a movement along the money demand
curve, but not a shift of the money demand curve.
49. A
(1) is correct. When the nominal interest rate of a country increases, the level of planned investment will
decrease as the interest rate is the opportunity cost of funds used to finance investment.
(2) is correct. When the nominal interest rate of a country increases, investment expenditure, consumption
expenditure and net exports will decrease. National income will therefore fall.
(3) is incorrect. When the nominal interest rate of a country increases, holding the interest rates in other
countries constant, foreign investment will flow into the country in order to earn a higher interest rate,
causing the country’s currency to appreciate (the value of domestic currency in terms of foreign currency to
increase).
50. A
When the interest rate of Country A increases while the interest rates in other countries remain constant,
foreign investment will flow into Country A in order to earn a higher interest rate, causing the country’s
currency to appreciate, i.e. the exchange rates of Country A’s currency to other currencies will increase.
51. B
When more people use Octopus Cards to deal with daily transactions, people will reduce the amount of cash
held for transactions. This would reduce the transaction demand for money as well as the total demand for
money. The money demand curve will shift to the left.
Option A is incorrect. The money supply will not be affected.
Option C is incorrect. Given the money supply curve, when the money demand curve shifts to the left, the
nominal interest rate will decrease.
52. C
If the demand for money decreases, there will be a leftward shift of the money demand curve. The nominal
interest rate will decrease. To stabilise the nominal interest rate, the central bank has to reduce money
supply.
When the central bank raises the required reserve ratio, given the same amount of reserves held, the
commercial banks will not have enough required reserves for their deposits. In order to satisfy the higher
reserve ratio, they need to reduce their lending or even call back loans from the public. Through deposit
contraction, money supply will decrease.
53. B
When money demand decreases, the money demand curve shifts leftwards. The equilibrium interest rate will
decrease. This will lead to an increase in the consumption expenditure.
54. B
Total demand for money ($) Money supply ($) Nominal interest rate (%)
200 + 700 = 900 1,200 15
300 + 700 = 1,000 1,200 13
400 + 700 = 1,100 1,200 11
500 + 700 = 1,200 1,200 9
600 + 700 = 1,300 1,200 7
When the total demand for money is equal to the money supply ($1,200), the nominal interest rate is at
equilibrium which is 9%.
55. C
M1 = Currency held by the public + Demand deposits with licensed banks
M3 = M2 + Deposits with restricted licence banks and deposit-taking companies + Negotiable certificates of
deposit issued by restricted licence banks and deposit-taking companies held outside the banking sector
Since the $2,000 cash received from overseas is deposited in a restricted licence bank, M3 will increase
while M1 will remain unchanged.
56. A
Lowering the legal reserve requirement for banks implies a lower minimum reserve ratio. This will increase
the amount of deposits that banks can lend out. In other words, the deposit creating ability of the banking
system will increase.
57. D
The increase in the price level will lead to an increase in nominal income, leading to an increase in
transaction demand for money. The money demand curve will therefore shift to the right.
58. C
(2) is incorrect. Only legal tender notes and coins held by the public are included in the money supply M2.
59. B
M1 = $(30 + 10) million = $40 million
M2 = $(40 + 5 + 3) million = $48 million
M3 = $(48 + 8 + 5) million = $61 million
60. A
Change in money supply M1
= The change in demand deposit (-HK$550,000) + The change in cash held by the public (+HK$50,000)
= -HK$500,000
Change in money supply M2 = Change in money supply M1 = -HK$500,000
Change in money supply M3
= Change in money supply M2 + The change in time deposit account with a restricted licence bank
(+HK$500,000)
= -HK$500,000 + HK$500,000 = HK$0
61. D
M1 M2 M3
Anthony withdraws HK$200,000 --- --- ---
from his current account.
He remits HK$100,000 to the -$100,000 -$100,000 -$100,000
United States.
He puts the remaining -$100,000 --- ---
HK$100,000 into his time deposit
account with a licensed bank.
Net change -$200,000 -$100,000 -$100,000
62. A
Original money supply = $100 + $1,000 = $1,100
Required reserve ratio = [($300 – $100) / $1,000]  100% = 20%
New money supply = ($100 + $100) + [$200  (1/20%)] = $1,200
The money supply will increase.
63. B
Required reserves = $25 – $5 = $20
Deposits = $20  (1/20%) = $100
For (1), actual reserve ratio = ($25 / $100)  100% = 25%
For (3), money supply = cash in public circulation + deposits = $50 + $100 = $150
(2) is incorrect. Maximum possible amount of deposits = $25  (1/20%) = $125
64. D
For (1), Maximum banking multiplier = 1/Required reserve ratio
Raising the required reserve ratio will lead to a decrease in the maximum banking multiplier.
For (2) and (3), when the required reserve ratio is raised, the reserves held by the banking system are not
sufficient to fulfil the minimum reserve requirement. Banks have to call back some of the loans from debtors
or sell some of their assets to the public in order to fulfil the reserve requirement. Through deposit
contraction, money supply will decrease.
65. B
Money supply = Cash in public circulation + Bank deposits
$2,200 = $200 + Bank deposits
Bank deposits = $2,000
Bank reserves = $2,000  25% = $500
Monetary base
= Cash in public circulation + Bank reserves
= $200 + $500 = $700
66. C
For (1), Monetary base = Cash in public circulation + Reserves
Neither the cash in public circulation nor the reserves held by the banks change after the deposit creation
process is completed.
For (3),
Required reserve ratio = [($150 million – $50 million) / $500 million]  100% = 20%
Maximum possible amount of deposits = $150 million  (1/20%) = $750 million
Original money supply = $100 million + $500 million = $600 million
New money supply = $100 million + $750 million = $850 million
For (4), maximum possible amount of loans = $750 million – $150 million = $600 million
(2) is incorrect. Maximum banking multiplier = 1/Required reserve ratio. As the required reserve ratio does
not change, the maximum banking multiplier will not be affected.
67. C
Negotiable certificates of deposit, time deposits and bonds have a fixed maturity period and cannot be
marketable quickly.
68. A
When nominal interest rate increases, people that choose to hold money as an asset for the purpose of
storing wealth (asset demand for money) forgo more return from holding other interest-bearing assets.
Therefore, the opportunity cost of holding money will increase and people will hold less money as an asset
and the asset demand for money will decrease.
69. B
When the time interval between income payments decreases, there will be a better synchronisation between
income payments and expenditures. People will hold less money for purchasing goods and services. Money
demand will decrease and the money demand curve will shift to the left.
Option A is incorrect. When people expect a lower inflation rate in the future, nominal interest rate will
decrease. There will be a downward movement along the same money demand curve, instead of a shift of
the money demand curve.
Option C is incorrect. An increase in the general price level will raise the amount of money held for
transaction purposes. Money demand will increase and the money demand curve will shift to the right.
Option D is incorrect. When there is an increase in people’s wealth, the amount of money they hold as an
asset will increase. Money demand will increase and the money demand curve will shift to the right.
70. A
When people’s nominal income increases, the total value of transaction will increase and people will hold
more money for transaction.
(2) is incorrect. When the returns from holding other interest-bearing assets increase, people will tend to
hold less money in their asset portfolio. This will affect the asset demand for money.
(3) is incorrect. When there is an increase in people’s wealth, the amount of money they hold as an asset will
increase. This will affect the asset demand for money.
71. C
For (2), when the risk of holding other interest-bearing assets increases, people will tend to hold more
money. Money demand will increase and nominal interest rate will increase.
For (3), when the central bank raises the required reserve ratio, money supply will decrease. Nominal
interest rate will increase.
(1) is incorrect. When the number of people using credit cards to settle payments increases, people will tend
to hold less money for transaction. Money demand will decrease and nominal interest rate will decrease.