ECONOMICS How Money is Created in the Banking System-worksheet

A. Answer the following questions. 10 points

B. Load your answers into the D2L Assignment with the name of this Topic

Questions:
1. If you deposit a $20 bill into a checking account and your bank has a 10 percent
reserve requirement, by how much in dollars will the bank’s excess reserves rise?

2. Consider this statement: “Banks do not create money because this is the Fed’s
responsibility.” Explain why the statement is incorrect.

3. Assume the Fed has a 20 percent required reserve ratio. What amount of dollars of
checkable deposits can ideally be supported by $10 million in required reserves?

4. Suppose you deposit your paycheck drawn on another bank. Explain the impact on
the money supply. Clarify how there is no change in the money supply in this case.

5. During the Great Depression in the 1930s, before the creation of the Federal
Deposit Insurance Corporation by Franklin D. Roosevelt, many banks were rumored
to go broke. Thus, panicked depositors tried to withdraw their money at the same
time, which caused many banks to indeed go bankrupt. Answer the following
questions.
a. As more banks went broke in the Great Depression, how did this case of
negative excess reserves affect the supply of money in circulation? [Be sure to
include the multiplier effect –in this case negative - in your answer. This is a
case of the multiplier effect, but in reverse.] This was a primary cause of the
extreme severity and length of the Great Depression: There was not enough
money in circulation, so people could not buy goods, there were lay-offs and
unemployment, there was deflation, which discouraged investment by
businesses, which led to more unemployment and poverty. Vicious circle.

b. In this case of the Great Depression, explain how the action of individual
depositors to withdraw their money is a case of the “Fallacy of Composition.”

c. The Federal Deposit Insurance Corporation was created in 1933 by the Franklin
D. Roosevelt Administration. What did the Federal Deposit Insurance
Corporation do to prevent runs on the banks?

d. We see now in 2020 and 2021 with the Covid pandemic that the Federal
Reserve has encouraged borrowing by setting very low interest rates, and the
Congress has passed out much money to individuals in these years (I myself
received more than $2500 from the US Treasury.) As compared to the Great
Depression, what is the intent of the Federal Reserve and the Congress in
2020-2021?

1
6. Assume the required reserve ratio is 10 percent and a bank’s excess reserves are
$50 million. Explain why checkable deposits resulting from new loans based on
excess reserves are not likely to generate the maximum of $500 million.

7. Describe in a few words the effect on the money supply of each of the following
monetary policies:
a. The Fed purchases $20 million worth of U.S. Treasury bonds.

b. The Fed increases the discount rate.

c. The Fed decreases the discount rate.

d. The Fed sells $40 million worth of U.S. T-bills.

e. The Fed decreases the required reserve ratio from 10% to 5%.

8. What are two problems faced by the Fed in controlling the money supply?

********************************************* **