Question

1.Can ice cream be money? Answer the question considering the three functions we discussed.

2. What does it mean “fiat money” and why the modern economies moved to this payments system?

3. What are the small denomination time deposits? Why are they in M2 and not in M1?

4. Calculate the deposit multiplier in the case of a reserve requirement of 15 percent.

5. What is the relation between the reserve requirement and the deposit multiplier? Discuss and provide one example.

Answer 1

Answer 1. Ice cream cannot be money since is doesn't serve the three basic purpose of money. Ice cream cannot be stored for long, so it doesn't have store of value. Ice cream also doesn't the flexibility as the measure of value. Ice cream has difficulty to be accepted as a means of exchange, since everyone may not like it, yet will be forced to trade in it.

Answer 2. Fiat money is the money approved by the government to be used as a mediun of exchange. It is the currency notes, coins etc that are approved and promoted by the government to be accepted as a medium of exchange while buying and selling goods and services.

Fiat money helps government ensure monetary stability and uniformity.

Answer 3. Smaller denomination time deposits are less than $100,000 like Certificate of deposits or time deposits etc. These are deposits for a short duration like few months to few years which helps earn Interest rate.

It is included in M2 and not M1 because it has slight difficulty to be converted back to the currency.

Answer4. Deposit ratio=1/ Reserve requirement ratio= 1/(15%)= 6.67

Answer 5. There is inverse relationship between Feposot multiplier and reserve requirement ratio.

Higher the reserve Ratio, lower will be the deposit multiplier.

Example- Let reserve requirement ratio= 20%

Deposit multiplier= 1/20%= 5