Question

dont plagerize and explain in your own words

1. How (the primary way) money is created in the economy. In your explanation you must correctly apply the following terms: actual reserves, required reserves, and excess reserves.

2. Why is the banking system in the United States referred to as a fractional reserve bank system?

3. What is the role of deposit insurance in a fractional reserve system?

Answer 1

Question 1)

In any modern economy, commercial banks create money by giving them away as loans. The banks need to hold only a proportion of their deposits as required reserves with the Federal Reserve of the country. The rest of the money is referred to as excess reserves which the bank uses to generate money in the economy.

This is done by creating loans and checkable deposits against the deposited amounts. So, for example if the Cash Reserve Ratio is 10%, the bank can then create money out of the remaining 90% excess reserves which it holds.

The actual reserves of a bank include those reserves which it gives away as loans (excessive reserves) and those which it needs to hold with the federal reserve (required reserves).

Question 2)

The United States is referred to being a fractional reserve bank system, as the commercial banks are expected to only keep a fraction of the deposits in the form of reserves and the remaining amount is given away as loans which make profits for the bank respectively.

This works basically because people do not desire to withdraw all of their money at once. Even when some people may be interested in withdrawing all their money also, yet their numbers are very few.

Question 3)

Deposit Insurance is a guarantee which is mostly given by the government whereby some part of the deposit is insured against bank failures.

When bank failures take place, the liabilities of the bank rise to a level whereby it may not be able to pay off all its obligations towards depositors. To avoid this from happening, a proportion of your holdings with banks are insured against any damage which may happen to the bank itself.

Thus, to protect you in case a bank goes bust, the concept of deposit insurance is prevalent in countries that run on fractional reserve system.

Please feel free to ask your doubts in the comments section.