ECON 310 009 Money & Banking J. Scott Sperling
Problem Set 5
Due: 2 May, 2002
Complete each of the following questions. Your answers should be typed (mathematical expressions and
graphs may be hand written). You may work in groups to complete the assignment, but each person must
hand in their own paper. This assignment will be graded as if it were an exam.
1. In your own words, explain each of the following terms and give an example of each. (20 points)
•adverse selection
•moral hazard
•principal-agent problem
•free-rider problem
2. There are three factors which contribute to financial innovation. Identify each factor, briefly describe
how each factor affects financial institutions’ incentives to innovate, and give an example of an innovation
which has occured due to each factor. (15 points)
3. True, False, or Uncertain: The Fed can accurately control the money supply through open market
operations and discount lending. Defend your answer in five or fewer sentences (more weight will be put
on your explanation). (5 points)
4. True, False, or Uncertain: Deposit insurance decreases assymetric information and moral hazard prob-
lems. Defend your answer in five or fewer sentences (more weight will be put on your explanation). (5
points)
5. Suppose the Fed buys $100 million of deutsche marks with Federal Reserve Notes and, at the same time,
sells $100 million of U.S. government securities for cash in a domestic open market operation. What is the
net effect on the monetary base? How has the Fed’s balance sheet been affected? (5 points)
6. If the required reserve ratio is 25%, banks hold no excess reserves, and the public holds currency equal
to 25% of deposits, what is the value of the money multiplier? (5 points)
7. Suppose that the statistics for the economy as whole (in billions of dollars) are as follows: currency
held by the public is 100, reserves held by banks is 200, checkable deposits held at banks is 800, and excess
reserves held by banks is 40. If the required reserve ratio on checkable deposits is 20%, what is the value of
the money multiplier? (5 points)
