How Money is Created in the Banking System

Question 1

The RR (required reserve ratio) is 10%.

The required reserves = 10/100 X $20

                                          =$2

If the bank has a 10% on reserve requirement, it must hold 10 percent of all deposits in reserve

and cannot lend out or invest this money. For every $100 deposited into the bank, $10 must be

held in reserve, and the other $90 can be lent out or invested. In this case, if a customer deposited

a $20 bill, the excess on bank reserves would rise by $2.

Question 2

The statement is incorrect because banks do create money. The act of a bank making a loan

means that it creates new money and puts it into circulation. This new money then circulates

through the economy and can be used by individuals to purchase goods and services. The Fed's

responsibility is to oversee the banking system and ensure that it operates smoothly, but banks

create money through the lending process.

Question 3

Required reserve = 20%

Amount in required reserves = $10 million

Checkable deposits that can be supported by $10 million = $10 million divided by 20%

$10/ (20/100) = $50 million

Therefore, $10 million in required reserves can support $50 million in checkable deposits. This is

because the reserve requirement is 20%. So, for every $1 in required reserves, $5 in checkable

deposits can be supported.

Question 4

A deposit of a check drawn from another bank does not impact the money supply because the

check is simply an order to transfer funds between banks (from one bank to another bank). Thus,

money supply is not affected because the total amount of money in the entire banking system

remains the same. The only difference is that the money is now in your bank account instead of

your wallet.

Question 5

a) The multiplier effect, in reverse, meant that as more banks went broke, the supply of

money in circulation decreased. This led to a decrease in consumption, as people did not

have enough money to buy goods. This, in turn, led to layoffs and unemployment, as

businesses could not sell their goods. Deflation then set in, as the supply of money

decreased while the demand for goods remained the same. This discouraged businesses

from investing, as they did not expect to make a profit, and led to even more

unemployment and poverty.

b) The fallacy of composition occurs when people reason that what is true for the part must

be true for the whole. In this case, individual depositors reasoned that they would be

better off if they withdrew their money from the bank. However, they did not consider

that if everyone withdraws their money from the bank, the bank will go bankrupt, and

everyone would be worse off.

c) The Federal Deposit Insurance Corporation (FDIC) provided deposit insurance to

depositors in U.S. banks during the Great Depression in the 1930s, therefore, cushioning

the banks from running bankrupt. This insurance protects against the loss of deposits if

the bank fails.

 d) The intent of the Federal Reserve and Congress in 2020-2021 is to stimulate the economy

by encouraging borrowing and spending to prevent the economy from collapsing. This is

in contrast to the Great Depression when the goal was to stabilize the banking system and

prevent panic withdrawals.

Question 6

The required reserve percentage is the proportion of deposits a bank must hold in reserve. In this

case, required reserve percentage is 10 percent, so for every $100 in deposits, the bank must hold

$10 in reserve. If a bank has excess reserves of $50 million, it can lend out up to $500 million in

new loans. However, the reason that checkable deposits consequential from new loans grounded

on excess reserves are not prospective to produce all-out of $500 million is because the required

reserve ratio is 10 percent. For every $100 in new loans, the bank can only lend out $90 because

it must hold $10 in reserve.

Question 7

a) The effect of the Fed's purchase of $20 million in Treasury bonds is to increase the

money supply. The Fed's purchase of $20 million in Treasury bonds would increase the

money supply because the Fed would be injecting new money into the economy. This

purchase would inject this money into the economy because it is a transaction between

public and private parties. Assuming that $1 of public money for every $1 of private

money exists as cash holdings, it is possible to increase public cash holdings by $20

million without printing any new currency or withdrawing any from circulation.

e) The discount rate is the interest rate charged by the Federal Reserve on loans made to

commercial banks and other depository institutions. An increase in the discount rate
 makes it more expensive for these institutions to borrow from the Fed, which in turn

reduces the amount of money they have available to lend to consumers and businesses.

f) If the Fed decreases the discount rate, it will lead to an increase in the money supply

since this would reduce the cost of borrowing from banks. This would then upsurge the

sum of money that banks have available to lend

g) If the Fed sells $40 million worth of U.S. T-bills, the money supply will decrease by $40

million. The Fed would receive $40 million for the T-bills, which would be removed

from circulation. This would decrease the money supply.

h) The money supply will upsurge because the required reserve ratio has decreased. This

means that banks will lend out more money since the required reserve that they should

keep has reduced

Question 8

The first problem faced by the Fed in controlling the money supply is that the demand for money

is constantly changing. The second problem is that the money supply is not infinite, so the Fed

has to be careful not to create too much money and cause inflation.