Question

Chapter 13 Questions next page

Chapter 13
1.) Origins of Banking) Discuss the various ways in which London goldsmiths functioned as early banks.
        

2.            (Fiat Money) What is fiat money? What type of money does the U.S. use? Most economists believe that the better fiat money serves as a store of value, the more acceptable it is. What does this statement mean? How could people lose faith in money?
         

3         .(Depository Institutions) Explain why a bank typically holds as reserves only a fraction of its deposit liabilities? In light of this arrangement, why is it important that depositors have confidence in their bank’s health?
    
4.            (Federal Reserve System) What are the main powers and responsibilities of the Federal Reserve System? What are its two mandates and some of its other goals?
    
5.        (Subprime Mortgages) What are subprime mortgages, and what role did they play in the financial crisis of 2008?

Answer 1

1.Goldsmiths accepted from their customers deposits of gold, which were available to the depositors upon request. Because the amount of idle gold on deposit tended to remain relatively constant, the goldsmiths began to lend out some deposits to earn interest. Goldsmiths also accepted written instructions from their depositors to transfer gold to other people—creating the first checks. Then the goldsmiths began making loans by simply creating checking accounts for borrowers. As a result, total deposits exceeded the value of gold actually in the goldsmiths' vaults—the creation of fractional reserve banking.

2.Fiat money refers to any currency lacking intrinsic value that is declared legal tender by a government. In this respect, unlike currencies backed by gold or silver, fiat money does not have any intrinsic value (e.g., paper money and much coinage). The U.S. dollar is an example of fiat money.The U.S. dollar is considered to be both fiat money and legal tender, accepted for private and public debts. According to me the statement means that people take fiat money as valuable as long as they believe in the government’s power to back up the currency andhave faith that the government in place will be there to enforce fiat money is widely accepted as a mean of payment. People could lose faith in money if government collapses and inflation takes over the economy where money loses its value therefore people can no longer buy the same goods for the same amount.

3.Banks keep a fraction of deposits as Reserves because a prudent banker, by his experience, knows that all the depositors do not approach the banks for withdrawal of money at the same time and also they do not withdraw the entire amount in one go..A bank knows that by keeping even a fraction of its deposit liabilities it can satisfy the withdrawal of its customers and maintain their trust.The banking system of any country is built on an edifice of trust that depositors have in their banks. The confidence that money is safe, keeps depositors away from withdrawing their funds unless they really need it. If everyone withdrew their money from banks, there would be some serious fallout. In addition to not having enough cash to cover the deposits, banks would be forced to call in all outstanding loans.

4.The Federal Reserve System is authorized to ensure sufficient money and credit in the banking system that is needed to support a growing economy. The Fed also has the power to buy and sell government securities, such as bonds, to make loans to member banks, to clear in the banking system, and to require that member banks hold a reserve requirement equal to a portion of their deposit.The Fed has the following goals like economic growth, stable interest rates, stable financial markets, and stable exchange rates. The Congress has directed the Fed to conduct the nation's monetary policy to support three specific goals like maximum sustainable employment, stable prices, and moderate long-term interest rates. These goals are sometimes referred to as the Fed's mandate