Macroeconomics Test 4 Flashcards

Fractional Reserve Banking

• Fractional reserve banking involves banks holding only a portion of deposits as reserves.
• Originated with goldsmiths issuing paper receipts exceeding the gold held.

Consequences of Fractional Reserve Banking

• Banks are susceptible to panics or bank runs due to the fractional reserve system.

Bank Financials

• A bank's net worth is calculated as assets minus liabilities.
• One key element of money supply M1 includes a bank's liabilities.

Bank Deposits and Loans

• Depositing cash into a checkable-deposit account increases the bank's liabilities.
• When required reserves are less than actual reserves, banks can issue loans.
• Money is "created" through bank loans to customers.

Regulation and Reserves

• Commercial banks are mandated to keep required reserves at the Fed to control lending.
• Banks cannot obtain additional excess reserves by purchasing Treasury securities from the Fed.
• Holding excess reserves decreases the money-creating potential of the banking system.

Monetary Policy and Multiplier Effect

• The effective monetary multiplier, when the reserve ratio is 20% and banks hold 5% in excess, is 4.
• Maximum expansion of checkable deposits equals excess reserves multiplied by the monetary multiplier.

Demand for Money

• Consumers hold money to satisfy spending needs, demonstrating transactions demand for money.
• Transactions demand is generally not influenced by interest rates.
• A fall in interest rates leads to an increase in the total amount of money demanded.

Money Supply and Interest Rates

• Interest rates decrease when the quantity of money supplied exceeds the quantity demanded.
• Loans to commercial banks by the Federal Reserve are assets for the Fed and liabilities for banks.

Federal Reserve Operations

• U.S. Treasury deposits are liabilities for the Fed and assets for the U.S. Treasury.
• The Fed manipulates reserves primarily through required-reserve ratios and not through exchange rates.
• The Fed enhances the lending ability of banks by purchasing securities in open markets.

Impact of Fed Actions

• The Fed alters the nation's money supply by changing the amount of excess reserves.
• Lowering the reserve ratio increases banks' excess reserves.
• The main intention behind the Fed buying government securities is to boost bank lending.

Consequences of Reserve Changes

• Lowering the reserve ratio converts required reserves into excess reserves.
• Increasing the legal reserve ratio decreases excess reserves and contracts the money supply.
• The Federal funds rate refers to the interest that banks charge for lending excess reserves to each other.

Economic Effects of Money Supply

• An increase in the money supply usually results in lower interest rates and higher aggregate demand.