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).
What does the T-account show about a bank's financial position?
It shows the bank's assets (what it owns) and liabilities (what it owes), which must always balance.
In a bank balance sheet, what does 'demand deposits' represent?
It represents the money held in checking accounts, which is a liability for the bank.
On a T-account, how do you calculate the amount of new loans a bank can make?
New loans = Excess Reserves. Excess reserves = Total Deposits - Required Reserves.
How do you determine required reserves from a bank balance sheet?
Multiply the demand deposits by the reserve ratio.
In a bank balance sheet, what are the main components?
Demand Deposits, Required Reserves, Excess Reserves, and Loans.
What does the asset side of a bank's balance sheet represent?
It represents what the bank owns, including reserves and loans.
What does the liabilities side of a bank's balance sheet represent?
It represents what the bank owes, primarily demand deposits.
What does it mean if a bank's assets do not equal its liabilities?
It indicates an error in the balance sheet; assets must always equal liabilities.
How do you analyze a T-account to determine the potential change in the money supply?
Multiply the excess reserves by the money multiplier.
How does a new deposit impact a bank's T-account?
It increases both the bank's assets (reserves) and liabilities (demand deposits).
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.
