ScienceEconomicsEcon chapter 15 example #53326
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Econ chapter 15 example #53326

Sabrina Edwards avatar Sabrina Edwards
14 January 2024
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In a fractional reserve banking system,
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banks can create money through the lending process.
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Fractional reserve banking refers to a system where banks
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hold only a fraction of their deposits in their reserves.
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The reserves of a commercial bank consist of
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deposits at the Federal Reserve Bank and vault cash.
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The primary purpose of the legal reserve requirement is to
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provide a means by which the monetary authorities can influence the lending ability of commercial banks.
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Excess reserves refer to the
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difference between actual reserves and required reserves.
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The reserve ratio refers to the ratio of a bank's
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required reserves to its checkable-deposit liabilities.
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The amount that a commercial bank can lend is determined by its
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excess reserves.
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In prosperous times, commercial banks are likely to hold very small amounts of excess reserves because
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Federal Reserve Banks pay lower rates of interest on bank reserves than could be earned by the commercial banks loaning out the reserves.
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A bank temporarily short of required reserves may be able to remedy this situation by
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borrowing funds in the federal funds market.
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The market for immediately available reserve balances at the Federal Reserve is known as the
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federal funds market.
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When a bank loan is repaid, the supply of money
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is decreased.
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Money is "created" when
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a bank grants a loan to a customer.
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Other things being equal, an expansion of commercial bank lending
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increases the money supply.
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The greater the leverage in the financial system, all else equal,
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the greater the instability of the financial system.
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The term "leverage" refers to
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using borrowed money in an attempt to increase profits.