Survey of Economics – Chapter 16:3 (Banking & Money Creation)

Question-and-Answer flashcards covering the key concepts of banking balance sheets, reserves, the deposit multiplier, and money creation from Chapter 16.

What is typically the largest ASSET and the largest LIABILITY on a bank’s balance sheet?

Loans are the largest asset and deposits are the largest liability.

If you withdraw $100 in cash from your checking account, how does your bank’s balance sheet change?

Reserves decrease by $100 and deposits decrease by $100.

How do banks ‘create money’?

When checking-account deposits increase, banks gain reserves, make new loans, and the money supply expands.

What is the formula for the simple deposit multiplier?

Simple Deposit Multiplier = 1 ÷ Required Reserve Ratio (RR).

With RR = 0.05, a $5,000 increase in reserves can raise checking deposits by how much?

By up to $100,000 (because 1/0.05 = 20; 20 × $5,000 = $100,000).

In banking terminology, what is ‘commercial lending’?

Loans that banks make to businesses.

‘Loans are funded by deposits.’ Is this statement correct?

Yes. Deposit funds supply the bank with capital that can be loaned out for profit.

Why don’t most savers lend directly to friends at higher rates instead of keeping low-interest bank CDs?

Because there is a risk that the borrower will not repay the loan.

If RR = 10 % and a new $100,000 deposit enters Wells Fargo, what is the bank’s maximum NEW loan?

$90,000.

Define REQUIRED RESERVES.

The minimum fraction of deposits a bank must legally keep as reserves (vault cash or Fed deposits).

Define EXCESS RESERVES.

Reserves a bank holds above the legal requirement.

If a bank has $10,000 in reserves and $70,000 in deposits with RR = 10 %, how much are its excess reserves?

$3,000 (required = $7,000; excess = $10,000 – $7,000).

For the same bank, what is the maximum amount it can expand its loans immediately?

$3,000 (equal to its excess reserves).

Are checking-account deposits assets or liabilities for a bank?

Liabilities, because the bank owes that money to depositors.

With RR = 20 %, a $2,000 cash deposit can ultimately raise checking deposits by how much?

Up to $10,000 (deposit multiplier 1/0.20 = 5; 5 × $2,000).

With the same example, what is the maximum increase in the money supply?

$8,000 (new deposits $10,000 minus the original $2,000 cash).

What is the correct definition of RESERVES?

Deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve.

What are a bank’s required and excess reserves if it holds $2,300 in reserves against $11,500 in deposits with RR = 14 %?

Required reserves = $1,610; excess reserves = $690.

Why don’t banks loan out every penny of their deposits?

They must hold a fraction of deposits as required (and desired) reserves.

If RR = 15 % and bank reserves rise by $40 billion, total checkable deposits can increase by approximately how much?

About $267 billion (40 ÷ 0.15 ≈ 266.7).

An initial decrease in bank reserves will change total deposits in what way?

Deposits will fall by an amount greater than the initial reserve loss (multiplier in reverse).

Which item is the largest liability of a typical bank?

Deposits.

Which term refers to the legal minimum fraction of deposits a bank must hold as reserves?

The required reserve ratio.

If a bank has $500 in deposits and RR = 10 %, what are its required reserves?

$50.

What does the SIMPLE DEPOSIT MULTIPLIER equal conceptually?

The reciprocal of the required reserve ratio, and it shows the maximum change in deposits from new reserves.

How does raising the required reserve ratio affect the simple deposit multiplier?

It decreases the value of the simple deposit multiplier.

How does a rise in the excess-reserves banks choose to hold affect the real-world deposit multiplier?

It decreases the real-world deposit multiplier.

Complete the phrase: When banks gain reserves and make new loans, the money supply ; when they lose reserves and cut loans, the money supply .

expands; contracts.