Fractional Reserve Banking

largest means of payments are savings accounts
savings accounts, money market mutual funds, and small-time deposits require extra work to be used as payment
- typically must transfer the money to a checking account before you can use it

money supply can be defined in different ways depending on which liquid assets are included
3 most important definitions:

what makes Federal Reserves job difficult/interesting?
- the Federal Reserve ultimately aims to influence aggregate demand by using its control over the money supply
which money supply does the Federal Reserve have control over?
- monetary base
which money supplies have the most significant effects on aggregate demand?
- M1 and M2
the central bank tries to use its control over the monetary base to affect M1 and M2
- many other influences on M1 and M2
- are also other influences on aggregate demand
in order to understand how the Federal Reserve influences M1 and M2 and aggregate demand, and why its influence is sometimes weak, we need to understand:

fractional reserve banking: a system in which banks hold only a fraction of deposits in reserve, lending the rest
when money is deposited into an account, the bank holds a fraction of the account balance in reserve and uses the rest to make loans
- banks earn profit on these loans
reserve ratio (RR): the ratio of reserves to deposits
- RR= reserves/deposits
if banks make profit from making loans, why do they keep any money in reserve?
- banks need those reserves to meet depositor demands for currency and payment services
- the law and the Federal Reserve require banks to keep some reserves
- often referred to as the “required reserve ratio” or reserve requirement
reserves involve opportunity costs
- money held in reserve is not being lent, and lending is where banks earn most of their profits
- banks balance these benefits and costs when deciding on the ratio between reserves and deposits