All Flashcards
Define Fractional Reserve Banking.
Banks hold only a fraction of deposits as reserves and loan out the rest.
What is the Reserve Ratio (rr)?
The fraction of deposits banks are required to keep as reserves, set by the Federal Reserve.
Define Required Reserves.
The amount of money banks must keep in their vaults or at the Fed.
What are Excess Reserves?
The amount of money banks can loan out.
What is the Money Multiplier?
Shows how much the money supply can expand from an initial deposit.
Define Liabilities (in banking).
What the bank owes to others (e.g., deposits).
Define Assets (in banking).
What the bank owns (e.g., reserves, loans).
What are Demand Deposits?
Money held in checking accounts (a liability for the bank).
Define Banks.
Financial institutions that accept deposits and make loans.
What is the reserve requirement?
The fraction of deposits banks are required to keep as reserves, set by the Federal Reserve (the Fed).
How does a lower reserve ratio affect the money multiplier?
A lower reserve ratio means a larger money multiplier and a greater potential change in the money supply.
How does a bank create money through fractional reserve banking?
By loaning out excess reserves, which then become someone else's deposits, restarting the process.
If a bank receives a new deposit, how does it determine how much it can loan out?
It multiplies the deposit by (1 - reserve ratio) to find the excess reserves available for loans.
How does the money multiplier impact monetary policy?
It shows how changes in the reserve ratio can significantly affect the money supply, influencing inflation and economic growth.
Explain how excess reserves are calculated.
Excess Reserves = Total Deposits - Required Reserves
How do required reserves impact the amount of money a bank can loan?
The higher the required reserves, the less money a bank can loan.
What happens to the money supply if people start holding more cash instead of depositing it?
The money multiplier effect is reduced, leading to a smaller expansion of the money supply.
How does an increase in the reserve requirement impact the money supply?
It reduces the money multiplier, leading to a smaller potential expansion (or larger contraction) of the money supply.
How does fractional reserve banking create new money?
Banks loan out a portion of deposits, which are then re-deposited, creating more money in the economy.
How does the initial deposit affect the total change in the money supply?
The initial deposit is multiplied by the money multiplier to determine the maximum potential change in the money supply.
How does the Federal Reserve use the reserve requirement to influence the money supply?
By increasing the reserve requirement, the Fed reduces the money multiplier and contracts the money supply. Decreasing the reserve requirement increases the money multiplier and expands the money supply.
What is the impact of increasing the reserve requirement on banks' lending capacity?
It reduces banks' lending capacity, as they must hold a larger portion of deposits as reserves.
How does a change in the reserve requirement affect the money multiplier?
An increase in the reserve requirement decreases the money multiplier, and vice versa.
What is the effect of the Fed lowering the reserve ratio?
Banks have more money to lend, increasing the money supply and potentially stimulating economic activity.
How does the reserve requirement affect the overall economy?
It influences the amount of credit available, impacting interest rates, investment, and economic growth.
What is the impact of a higher reserve ratio on the money supply?
It decreases the money supply by reducing the money multiplier.
What is the impact of a lower reserve ratio on the money supply?
It increases the money supply by increasing the money multiplier.
How can the Fed use reserve requirements to combat inflation?
By increasing the reserve requirement, reducing the money supply and aggregate demand.
How can the Fed use reserve requirements to stimulate a recessionary economy?
By decreasing the reserve requirement, increasing the money supply and aggregate demand.
What are some limitations of using reserve requirements as a monetary policy tool?
Frequent changes can disrupt bank operations, and banks may choose to hold excess reserves, reducing the impact.