Question

Please answer the following questions:

1.What does it mean “Fiat Money” and why did the modern economies move to this payments system?

2.Calculate the total increase in deposit of a bank in the following case:

Initial deposit: $ 2,000
RRR: 20 percent

3. Which component of the Federal Reserve System decides on the reserve requirement and what will be the effect of its reduction?

Please answer them properly and Write in PRINT!

Answer 1

1 - Fiat money is the currency which is printed by the government of the country and which carries a certian fixed value. The fiat money is not backed up by gold or any previous item. It is based upon the trust of the public and the government.

The economists show much belief in this system of money because of the fact that the government will never fall short of money because it can always print the money and control its supply on the economy. The influence of inflation is lesser on this type of currency as it is not backed by gold . It is also a promissory note whereby the government promises to the holder of the currency to give him value equal to what is printed on currency.

2 - Total increase = Initial deposit * money multiplier

Money multiplier = 1/ reserve ratio

= 1/.20

= 5

Total increase in money supply = 2000*5

= $ 10000

Answer 3 - The board of governors of the federal reserve bank decide upon the reserve requirement. If the reserve requirement is reduced , this would lead to banks having more money to lend to general public. This will bring down the interest rates and lead to the rise in money supply in economy. This is part of expansionary monetary policy of fed.