Asked by Georgia Faulkner on May 12, 2024
Verified
In a fractional reserve economy where the required reserve ratio is 10%, must it be the case that an initial deposit of $100 increases the total money supply by $1,000? Explain.
Fractional Reserve Economy
An economic system where banks hold a portion of customers' deposits in reserve and lend out the remainder, thus creating money.
Required Reserve Ratio
The minimum fraction of deposits banks are required by law to keep as reserves, either in their vaults or on deposit at a central bank.
- Study the essential role of bank reserves, the workings of the money multiplier, and the effect of fractional reserve banking on the regulation of money supply.
Verified Answer
MS
Modutwane SefaraMay 19, 2024
Final Answer :
No, this is not necessarily the case.
It is true the total money supply can increase a maximum of $1,000. In general, there are two reasons the actual impact will be less than the maximum $1,000.
1) Banks often choose to hold reserves in excess of required reserve.
2) Rather than keep all wealth in the form of deposits at banks, people choose to hold currency.
These two factors cause the actual money creation in the banking system to be less than the maximum possible.
It is true the total money supply can increase a maximum of $1,000. In general, there are two reasons the actual impact will be less than the maximum $1,000.
1) Banks often choose to hold reserves in excess of required reserve.
2) Rather than keep all wealth in the form of deposits at banks, people choose to hold currency.
These two factors cause the actual money creation in the banking system to be less than the maximum possible.
Learning Objectives
- Study the essential role of bank reserves, the workings of the money multiplier, and the effect of fractional reserve banking on the regulation of money supply.