1. Define and discuss the reserve requirement and how it relates to the money multiplier.

Reserve requirements are the amount of funds that the banks must hold on reserve against specified deposit liabilities. The People's Bank of China has the authority to change the percentage of deposits that must be held. The funds may either be held in the form of cash or as deposits at the central bank. When the bank raises reserve requirements, as in the case with China, banks have to hold more of their deposits on reserve and therefore have less to loan out. This is referred to as contractionary or tight money monetary policy and is aimed at reducing inflation. The money multiplier effect is usually discussed in an expansionary environment, but this situation presents a good opportunity to show how the multiplier can work in reverse, with each successive lender having less money to pass along to the next.

2. Visit http://www.ny.frb.org/education/fed/tools.html to name and discuss two additional tools of monetary policy.

The other two tools of monetary policy are open market operations and the discount rate. When you go to http://www.ny.frb.org/education/fed/tools.html you find a detailed explanation of each tool. The material includes the potential impact on the economy as you change the various tools. The site is a great review that supplements the text well. It also includes a link to the latest figures for the federal funds rate, reserve requirements, and the discount rate. Explain to the students that central banks all over the world use these same basic tools of monetary policy.

Multiple Choice/True False Questions