Chicago. Undergraduate Money and Banking. Exams, readings. Friedman, 1946-49

 

Besides teaching in the core graduate price theory course at Chicago, Milton Friedman also covered undergraduate money and banking upon joining the faculty of the economics department. Below some material transcribed from a folder of course material found in Milton Friedman’s papers at the Hoover Institution Archives. Where answers were provided to some examination questions, they have been transcribed [and placed in square brackets] and included below.

Fun Fact: According to class rolls kept by Friedman, Marc Nerlove was a student in the Autumn 1951 Money and Banking class taught by Friedman.

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Course Announcement and Description

[Economics] 230. Introduction to Money and Banking. Study of factors which determine the value of money in the short and in the long run; and operation of the commercial banking system and its relation to the price level and general business activity. Prereq: Soc Sci 2 and Econ 210, or equiv. Aut: MWF 10:30 Friedman; Win: MWF 2:30; Mints.

Source:   University of Chicago. Announcements. The College and the Divisions, Sessions of 1947-1948. Vol. XLVII, No. 4 (May 15, 1947), p. 224.

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Text for Economics 230:

L. V. Chandler, The Economics of Money and Banking. Harper & Brothers.

The Book will be used again as a text when the course is given in the Winter Quarter. Give the number in class as that of the Autumn, 1947.
Reserve List & Bookstore.

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Economics 230
Autumn 1947
Library Book List

Robertson, D. H. Money

Gregory, T. E. The Gold Standard and Its Future (3^rd)

Board of Governors. Federal Reserve System.Its Purposes and Function

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Economics 230
Autumn 1951

Supplementary Readings and Problem for Reading Period

Readings

Text: Lester Chandler, Economics of Money and -Banking

1. American Economic Association, Readings in Monetary Theory, edited by Friedrich Lutz and Lloyd W. Mints.
2. Goldenweiser, E.A., American Monetary Policy.
3. Gregory, T.E., The Gold Standard and Its Future.
4. Hardy, C.O., Credit Policies of the Federal Reserve System.
5. Keynes, J.M., Essays in Persuasion.
6. Mints, Lloyd W., Monetary Policy for a Competitive Society.
7. Robertson, D.H., Money.
8. S. Board of Governors of the Federal Reserve System, The Federal Reserve System, Its Purposes and Functions.

 

Problem

            For a convenient date in 1951, estimate the maximum amount of currency and deposits that would have been outstanding if the banking system had used all the possibilities of monetary expansion available under the then existing laws and regulations about reserve requirements of member and non-member banks and about reserve requirements of Federal Reserve Banks. For purposes of the computation, assume (a) an unchanged amount of Treasury currency outstanding; (b) elimination of Treasury deposits with Federal Reserve Banks through purchase of government securities held by the Federal Reserve Banks. With respect to all other factors—such as percentage distribution of public’s money holdings among currency, demand deposits, and time deposits—you are to choose your own assumptions, the choice of reasonable assumptions and the presentation of evidence for them being an essential part of the problem.

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MIDQUARTER EXAMINATION IN ECONOMICS 230
[no date, though likely 1947]

1. Indicate the factors that principally determine—
   1. (15 points) The ratio of the amount of currency in circulation to the amount of bank deposits.
   2. (15 points) The ratio of the amount of bank deposits to the amount of reserves held by the banking system when there are no legal reserve requirements.
2. (35 points) In country A, important new discoveries of oil are made, driving down the price of oil in that country relative to the world price. Assume that this is the only important change relevant to international trade. Trace the effects of this change on exchange rates, gold flows, price levels, imports and exports, and incomes, in country A and in the rest of the world on the assumption (a) that a strict gold standard is in operation; (b) that inconvertible paper standards and fluctuating exchanges are in operation.
3. (35 points) Explain in detail the effects on Bank A and on the banking system as a whole arising from the deposit in bank A of $100 of newly-printed currency. The deposit is made by a worker who has just received the currency from the government. Assume the bank is fully exploiting its lending power.

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Economics 230
Midquarter Examination
November 5, 1948

1. (25 points) It has been argued that it would be profitable for a member bank to borrow from its Federal Reserve bank even at a rate of interest considerably higher than the rate the member bank charges to its customers; and that this is so because one dollar of additional reserves can support several dollars of additional deposits. For example, if $1 of additional reserves can support $5 of additional deposits, it is argued that it would be profitable (if we neglect the cost of making the loan) for a member bank that can lend at 6% to borrow at any rate up to 30%. Evaluate this argument.
2. (25 points)
   1. Nondeposit currency currently in circulation in the United States include Federal Reserve notes, silver certificates, United States notes (greenbacks) and National Bank Notes. In addition, there is a large volume of gold certificates outstanding but not in circulation. Indicate brieflythe historical origin of each of these types of currency, and the major episode in our monetary development each one symbolizes.
   2. What is the FDIC? What, in your view, is its essential function (which may not be the same as its announced purpose) in our current monetary structure?
3. (50 points) Indicate whether the operation described in the first column would, in the first instance, increase (+), leave unchanged (0), or reduce (-) the item listed at the top of each column. For simplicity, assume (a) that nonmember banks are notinvolved in any of the transactions, (b) that the Treasury deposits all funds received in a Reserve Bank and pays for all expenditures by checks on a Reserve Bank, (c) that all nondeposit currency is in the form of Federal Reserve Notes. Take account only of the essentially bookkeeping effects of the operation, not of subsequent effects. For example, in operation (1) the decline in currency outside banks and the Treasury might so disturb the public’s relative holdings of deposit and nondeposit currency as to lead subsequently to a conversion of deposits into nondeposit currency. Do nottake such subsequent effects into account.
   [+1 for each correct, -1 for each wrong, 0 for no entry]

 

Operation	Currency outside banks and Treasury	Member bank		Federal Reserve Bans
		Demand Deposits	Excess Reserves	Deposits	Excess Gold Reserves
Purchase of government bond by public
From Federal Reserve Bank
(1) with non deposit currency	[-]	[0]	[0]	[0]	[+]
(2) by check	[0]	[-]	[-]	[-]	[+]
From Treasury
(3) with non deposit currency	[-]	[0]	[0]	[+]	[0]
(4) by check	[0]	[-]	[-]	[0]	[0]
From public
(5) with non deposit currency	[0]	[0]	[0]	[0]	[0]
(6) by check	[0]	[0]	[0]	[0]	[0]
Purchase of government bond by Treasury from
(7) public	a [0] b [+]	[+] [0]	[+] [0]	[0] [-]	[0] [0]
(8) member bank	[0]	[0]	[+]	[0]	[0]
(9) Federal Reserve bank	[0]	[0]	[0]	[-]	[+]
Conversion of demand deposit by public into
(10) non deposit currency	[+]	[-]	[+] and [0] [-] and [-] [only if both]		[0]
(11) time deposit	[0]	[-]	[0]	[0]	[0]

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Final Examination for Economics 230
Autumn, 1946
3 hours and overnight.

Part I

1. Define briefly the following terms:
   1. Required reserves
   2. Open market policy
   3. Gold points
   4. Rediscount rate
   5. Inconvertible paper currency
   6. Transactions velocity of circulation
   7. The equation of exchange
2. What techniques are available to the Federal Reserve System for controlling the total volume of currency? How does each technique work? Under what conditions is each technique likely to be effective?
3. It is often asserted that in returning to gold at the pre-first-world-war parity Britain “overvalued” the pound. What does this statement mean? What kind of evidence would be required to test its validity and how should this evidence be interpreted? If the statement is true, what effects would overvaluation of the pound be expected to have on Great Britain? What factors would operate to remove these effects and to correct the overvaluation? What kinds of governmental policy, if any, would speed up the process of correcting the overvaluation?

Part II

4. (20 points) What is the 100% reserve proposal? Discuss its advantages and disadvantages as compared with the present system.
5. (30 points) A newspaper story of January 21, 1946, on President Truman’s budget message, had the following headlines and first two paragraphs:

“TRUMAN MAPS FIRST DEBT CUT SINCE 1930
CASH ON HAND TO OFFSET ’47 DEFICIT

“Washington—President Truman’s first budget proposes to spend $4,300,000,000 more than the government will collect, but for the first time since 1930, it won’t increase the national debt.
“Mr. Truman proposes to withdraw from the Treasury cash balance sufficient funds not only to offset this deficit but also to reduce the debt by $7,000,000.”

In answering this question assume that Government cash balances are held on deposit in member banks, and that no reserves are required for government balances.

(a) What is the monetary effect of financing the deficit by use of cash balances? Would this effect be deflationary or inflationary compared with such alternatives as raising additional revenue from taxes, or borrowing additional sums from (1) the nonbanking public, (2) member banks, (3) reserve banks.

(b) What is the monetary effect of using cash balances to reduce the debt? Discuss the effects if the bonds are purchased from 81) the nonbanking public, (2) member banks, (3) reserve banks.

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FINAL EXAMINATION, ECONOMICS 230, FALL, 1947

Part I

1. In speaking of monetary developments in the United States at the beginning of the nineteenth century, H. L. Reed remarks, “the country was so inadequately provided with specie that the advantages of a money economy were not sufficiently extended and diffused.” What do you think this statement means? Does it make sense as it stands? If not, can you suggest an interpretation of it that makes sense?
2. Explain in detail how, in a fractional reserve system, a given deficit in reserves may force a much larger contraction in currency. In your statement, indicate the factors that set a limit to the contraction and contrast the single bank with the banking system.
3. To what causes does Gregory attribute the breakdown of the Gold Standard in Great Britain in 1931?

 

Part II

1.    a. Assume that there is a free market in which English pounds exchange for American dollars. Indicate whether each of the following would, by itself, tend to raise or lower the price of a pound in terms of dollars.

1) An increase in tourist travel by Americans in England. [A. Raise]
2) A rise in dividend payments on American common stocks owned by British. [A. Raise]
3) A sudden craze in Britain for American films leading to increased showings of American films. [A. Lower]
4) Increased repayment by Britain of loans from the U.S. [A. Lower]
5) The raising of abnormally large amounts of relief funds in the United States to finance the shipment of special food packages to Great Britain. [A. Raise]

b. If England and the United States were both on a gold standard what words would it be reasonable to substitute for “raise the price of a pound in terms of dollars”? [A. “ship gold to Britain”] for “lower the price of a pound in terms of dollars”? [A.“ship gold to U.S.”]

c. You are asked what the total amount of money in the United States is. Discuss the problems of definition that would arise, indicating the considerations that would be relevant in deciding what to count as money.

d. Marriner Eccles, chairman of the Federal Reserve Board, recently proposed to Congress that member banks be required to set up a special reserve of 25 per cent of deposit liabilities in addition to existing reserves. Three members of the Federal Advisory Council—a council composed of private bankers who advise the Federal Reserve Board—testified against the proposal. The N. Y. Times reports them as maintaining that “it would reduce loans needed to finance production, and thus prove inflationary.” Discuss this statement.

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Economics 230
Final Examination
December 16, 1949

1. (100 points) Indicate whether each of the following statements is true (T), false (F), or uncertain (U) and state briefly the reason for your answer.
   1. Legal reserves held by a bank are a liability of the bank.
   2. Banks that are members of the Federal Reserve System may not count cash in their vault as part of their legal reserves.
   3. Every bank that is a member of the Federal Reserve System must carry Federal Deposit Insurance.
   4. Every bank that carries Federal Deposit Insurance must be a member of the Federal Reserve System.

5 and 6. Bank A sells a government bond to Bank B, both banks being members of the Federal Reserve Stem. This…

1. 5. …increases total member bank reserves.
   6. …does not change total deposit liabilities of member banks.

7, 8, 9. Bank A, which is a member of the Federal Reserve System sells a government bond to Mr. Jones. Bank A deposits the proceeds in its account with a Federal Reserve Bank. This…

1. 7. …increases total member bank reserves.
   8. …does not change total deposit liabilities of member banks.
   9. …increases the ratio of reserves to deposit liabilities.
      *  *  *  *  *
   10. Since banks can expand loans by several times the amount of excess reserves, a bank that could make additional sound loans at 5 per cent, could afford to pay much more than 5 per cent to induce individuals to deposit currency in the bank, since such a deposit would increase the bank’s excess reserves.
   11. The economic function of legal reserve requirements is to protect depositors in a bank against undue extensions of loans by banks.
   12. An expansion of investments and an expansion of loans by commercial banks have identical effects on the quantity of money.

13 through 16. Mr. Jones pays his Federal income tax with a check on a member bank. The Federal government uses this check to buy a government bond from a Federal Reserve Bank. This operation…

1. 13. …reduces total member bank deposit liabilities.
   14. …reduces total member bank reserves.
   15. …increases the ratio of member bank reserves to member bank deposit liabilities.
   16. …increases the excess gold reserves of the Federal Reserve System.
       *  *  *  *  *
   17. The post-war rise in prices in the United States was one of the factors making necessary the recent devaluation of the British pound.
   18. Any phenomena that would lead to an outflow of gold from the United States under a gold standard would lead to a fall in the price of the dollar in terms of foreign currencies under a system of inconvertible currencies and flexible exchange rates.

19, 20, 21. Suppose that under an international gold standard, foreign payments and receipts by the United States balance so that there is no net outflow or inflow of gold.

1. 19. A sudden increase of gifts by residents of the United States to non-residents would tend to lead to an outflow of gold from the United States.
   20. A reduction in the tariffs imposed by France on goods imported into France would tend to lead to an outflow of gold from the United States.
   21. A large technological advance in Great Britain lowering the price of automobiles produced in Great Britain would lead to an outflow of gold from the United States.
       *  *  *  *  *
   22. Under a gold standard, a decline in the rate of interest will tend to narrow the spread between the gold points.
   23. Under existing laws governing bank reserve requirements, a tendency for people to move from farms and small communities to large cities is, by itself, a factor tending to reduce the total quantity of money.
   24. A lengthening in the average pay-period (through, say, an increase in the proportion of workers paid monthly instead of weekly) is, by itself a factor tending to reduce the price level.
   25. K, in the cash balance equation, will be increased by anything that leads people to expect price to fall.
   26. The numerical value of V in the transactions type of equation of exchange depends on the definition of M.
   27. The equation of exchange demonstrates that an increase in the quantity of money must lead to an increase in prices.
   28. Since one man’s receipts are another man’s expenditures, it follows that the quantity of money can be changed only by capital transactions.
   29. The rediscount rate is used by the Federal Reserve system to discourage purchase of government securities.
   30. Monetary policy can be more effective in preventing inflation than in preventing deflation.

 

2. (50 points) “In the early history of our country there was a dearth of currency and specie. It was difficult to have cash on hand, especially when most of the specie was used to pay for imports.” (E. R. Taus, Central Banking Functions of the United States Treasury, 1789-1941, p. 22).

Discuss the economic meaning of these sentences. Do they make sense as they stand? If so, explain. If not, can you suggest any interpretation of them that does make sense? In your answer, emphasize analysis, not economic history.

3. (50 points)

“One method proposed for bringing the reserve position under control while protecting the market for government securities held by banks is to require banks to keep a reserve of government securities against deposits, in addition to present cash reserves…..In all essential respects, raising required reserve ratios by adding a security-reserve requirement is identical with a straight increase of cash reserve requirements, combined with an equivalent purchase of government securities by the Reserve Banks. The only significant difference is that the security-reserve proposal provides the member banks with the equivalent of a subsidy (in the form of interest on the bonds) to compensate for the loss of earnings on additional assets tied up as reserves.”
Do you agree? Justify your answer.

4. (50 points) Under our present monetary system, a desire on the part of the pubic to hold an increased fraction of its money in the form of currency and a decreased fraction in the form of deposits is said to be a factor making for a decrease in the total amount of money (currency plus deposits) in existence. Explain this statement in detail. In your explanation, distinguish between the effect of an outflow of cash on the individual bank and on the system.

5. (50 points) Currency in public circulation (“cash in pocket”) was approximately one-sixth of the total amount of money (currency plus demand deposits plus time deposits) in the United States in 1892, it fell fairly steadily to about one-twelfth in 1930, and then rose more or less steadily until it is again approximately one-sixth, or about the same level as in 1892. The initial decline was interrupted by a rise during the first World War; and the subsequent rise was accelerated during the second World War.
   How would you explain the long decline to 1930? The subsequent rise? This tendency for the ratio to rise during war time? (Note that there is no unambiguously “right” answer to this question. So far as I know, those movements have not been exhaustively studied, and hypotheses to explain them have not been tested. You are being asked to construct hypotheses about them).

 

Source:  Hoover Institution Archives. Papers of Milton Friedman, Box 76, Folder 8 “University of Chicago, Econ. 230”.

Image Source:  Cropped from a photograph of Milton Friedman, George Stigler, and Aaron Director at the founding meeting of the Mont Pelerin Society, 1947, Milton Friedman papers, Hoover Institution Archives,