Money Definitions

Money Definitions

Define: money, barter, checks, credit cards, money creation, financial intermediation, reserves, required reserves, and excess reserves

List and define three functions of money

Answer the following:  Why is money valuable?

List and define three measures of money supply

Banks can create money through ‘fractional reserve banking’.  Here is an example:  Harry deposits $5000 in Bank A.  Bank A has a required reserve of 10% of all deposits.  That means that Bank A must hold $500 in its vault (cash) and can loan the balance ($4500) to someone else.  Bill then takes a loan for $4500, and deposits it in Bank B.  The same sequence applies to Bank B.  Bank B must hold a required reserve of 10% of all deposits, thereby holding $450 in its vault.  Bank B can loan the balance ($4050), and so on…….  Money is actually created (multiplies) using fractional reserve banking.  How much is created is determined by the ‘potential’  money multiplier.  It is determined by the following:  Potential money multiplier = 1/required reserve, 1/.10 (10% expressed as a decimal) or 10.  That means that Harry’s initial deposit of $5000 has the potential to multiply to $50000, when all transactions are completed (meaning that after depositing their required reserve the banks have nothing left to loan).  One last note about required reserves, their amount is determined by the FED, and banks must hold them to satisfy customers that want to close either a savings or checking account for cash.

Here is the problem:  Calculate how much money will potentially be created with an initial deposit of $10000, and a required reserve of 20%.

Provide three reasons why U.S. government securities are attractive assets for banks