The Nature and Creation of Money
Read these sections, "What is Money?" and "The Banking System and Money Creation", to examine money and its impact on real GDP and the price level. Specifically, learn about what money is and its three functions. Distinguish between the M1 and M2 definitions of money. Also, learn about the money creation process and role of banks in it in a fractional reserve banking system. You will revisit certain sections of the chapter later in this unit.
The Banking System and Money Creation
Key Takeaways
- Banks are financial intermediaries that accept deposits, make loans, and provide checking accounts for their customers.
- Money is created within the banking system when banks issue loans; it is destroyed when the loans are repaid.
- An increase (decrease) in reserves in the banking system can increase (decrease) the money supply. The maximum amount of the increase (decrease) is equal to the deposit multiplier times the change in reserves; the deposit multiplier equals the reciprocal of the required reserve ratio.
- Bank deposits are insured and banks are heavily regulated.
- Similar to the passage of the Glass-Steagall Act during the Great
Depression, the Dodd-Frank Act was the comprehensive financial reform
legislation that responded to the financial crisis in 2008 and the Great
Recession.