Question

Explain how banks create money. Compare the effect on the money supply of accepting a cash deposit with that of making a loan.

Answer 1

ANSWER:

The money created by bank is not a paper money that bear the logo of the government owned bank. It's the electronic deposit money that flashes up on the screen when you check your balance at an ATM. Banks create new money whenever they makes loans 97% of the money in the economy today is created by banks,only 3% of money is still in that old-fashioned form of cash that you can touch. The Bank of England release a report in which they stated that commercial banks create money in the form of bank deposits,by making new loans. When a bank extend loans to their customers,they create money by crediting their customers accounts said by Sir Mervyn king, Governor of the Bank of England.

By comparing the effect on the money supply of accepting a cash deposit with that of making a loan is when cash deposits are not only a part of the money supply, they also affect when Government create and spread money throughout the economy in response to key movers like investment .In Investment people move large sum of money to earn high rate of return by depositing and by withdrawal. Bank deposit are a primary tools from which business grow and which tend to grow our economy. Now come over to loan bank bank can affects the money supply through loan that bank fund through cash deposit it receives. By using interest rates to creates their own profit banks are also creating money to increasing the money supply in the economy.banks cannot use all they are reserved for loan however the government requires them to keep a certain amount to satisfy withdrawal.

CONCLUSION:

Government control the money supply to influence inflation in other part of the economy through the federal fund rate. this is the rate at which bank lend to each other usually for overnight laws that allow Bank to meet very short term obligation or rays investment money for a brief period of time.Changing the rate also changes expectations regarding treasury Bond and other tool of the government uses to change the money supply.