Answer One Of The Following Questions In Around 200 Words
Answer One Of The Following Questions Around 200 Words In This Fo
Answer ONE of the following questions (around 200 words). In this forum, you will not see your peers' posts after you post. Option 1: How do banks create money in the United States? Carefully explain how the fractional reserve system works. Do a little research and determine the current reserve requirements. Are you surprised about the percentage of money that banks hold as reserves? Do you expect the reserve requirement to be higher or lower? Share your thoughts. OR Option 2: Consider the following items: Gold Coins Grocery Store Coupons Funds in a checking account Funds in a savings account 100 shares of Google stock Food Stamps Which of these items is the best example of money? Which is the worst? How would you order the list from most money-like to least money-like? Explain your reasoning.
Paper For Above instruction
In this discussion, I will address Option 1, which explores how banks create money in the United States through the fractional reserve banking system. The fractional reserve system allows banks to hold only a fraction of their depositors' reserves while lending out the rest. This process effectively creates new money within the economy. When a customer deposits money into a bank, the bank is required to hold a certain percentage—called the reserve requirement—as reserves. According to the Federal Reserve, the current reserve requirement for most banks in the US is 10%, although this rate has fluctuated historically and is sometimes adjusted based on economic conditions.
The mechanism works as follows: if a customer deposits $1,000, and the reserve requirement is 10%, the bank must keep $100 as reserves but can lend out $900. The borrower then spends this money, which is deposited into another bank, which in turn keeps 10% ($90) and lends out $810. This cycle continues, amplifying the total money supply through multiple rounds of deposits and lending. Essentially, banks create money by extending credit, which increases the total amount of money in circulation beyond the physical cash issued by the Federal Reserve.
I am surprised at how small the reserve requirement currently is, as it indicates that banks hold only a small fraction of their deposits as reserves. Historically, reserve requirements were higher, which limited the extent of money creation through lending. I would expect the reserve requirement to be lower during periods of economic intervention or crises, as seen during the COVID-19 pandemic, to encourage lending and economic activity. A lower reserve requirement enables banks to lend more, thus facilitating economic growth. Conversely, higher requirements could restrict lending but increase financial stability. Overall, the current reserve requirement seems appropriately calibrated to balance economic growth and stability.
References
Federal Reserve. (2024). Reserve Requirements. https://www.federalreserve.gov/monetarypolicy/reserve-requirements.htm
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Federal Reserve Bank of St. Louis. (2023). How Banks Create Money. https://www.stlouisfed.org/in-plain-english/how-banks-create-money
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