Write A 1-2 Page Essay Describing The Fractional Reserve Sys

Write A 1 2 Page Essay Describing The Fractional Reserve System Ensur

Write a 1-2 page essay describing the fractional reserve system. Ensure you clearly elucidate the fundamental principle underlying the global economic system, and how the global economy essentially lives on debt. Use 2 quality resources, excluding Wikipedia and similar pages. Use APA format, Times New Roman, double spaced, font size 12, and be sure to include a cover page. Note that the cover page and references are not included in the required page length.

Paper For Above instruction

The fractional reserve banking system is a fundamental component of the modern global economy, serving as the backbone of financial operations and monetary policy. This system operates on the principle that banks are only required to retain a fraction of their customers' deposits as reserves, lending out the remainder to generate economic activity. This mechanism facilitates credit creation, which is essential for growth and development but also introduces inherent risks and dependencies, particularly on the continued ability to borrow and lend.

At its core, the fractional reserve system relies on the trust that depositors will not withdraw all their funds simultaneously, allowing banks to lend a substantial portion of their reserves. When banks lend money, they effectively create new money in the economy, since the loans are deposited back into banking systems or spent, thus expanding the money supply (Mankiw, 2020). This process significantly amplifies the amount of money circulating within an economy relative to the actual physical reserves held by the banking institutions. As a result, economic growth is propelled by this creation of credit, but it also makes the economy vulnerable to shocks if confidence wanes or if there is a sudden increase in withdrawals.

The fundamental principle underpinning the global economic system is that economic activity is heavily dependent on debt. Governments, corporations, and consumers all participate in a web of borrowing and lending that sustains economic growth. Debt allows for the acceleration of consumption, investment, and innovation, but it also leads to a reliance on continuous borrowing. The global economy, therefore, "lives on debt," as the expansion of credit via fractional reserve banking maintains liquidity and financial stability, enabling growth even in periods of economic downturn (Rognlie, 2015).

However, this reliance on debt presents systemic risks. Excessive leverage can lead to financial crises, as seen in the 2008 global financial crisis, where risky lending practices and over-leverage resulted in a collapse of confidence and a severe economic downturn. The system's inherent fragility stems from its dependency on confidence, regulatory oversight, and central banks' ability to intervene. Thus, while fractional reserve banking facilitates economic development through credit creation, it also underscores the importance of prudent regulation and risk management.

In conclusion, the fractional reserve system is integral to the functioning of the global economy, enabling significant credit expansion and economic growth. Nevertheless, its design emphasizes the crucial role of trust and the dangers of excessive debt accumulation. The global economy's dependence on debt, driven by the mechanisms of fractional reserve banking, highlights both the potential for prosperity and the risk of financial instability, necessitating careful oversight and responsible lending practices (Kelton, 2020).

References

• Kelton, S. (2020). The Deficit Myth: Modern Monetary Theory and the Birth of the People's Economy. Chelsea Green Publishing.
• Mankiw, N. G. (2020). Principles of Economics (9th ed.). Cengage Learning.
• Rognlie, M. (2015). Deciphering the fall and rise of homeownership. Brookings Papers on Economic Activity, 2015(1), 1-63.