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Chapter 12: Problem 431

True or false: Because of "multiple expansion of bank deposits," individual commercial banks are able to lend several dollars for each dollar deposited with them.

Short Answer

Expert verified
False. While the entire banking system can create multiple dollars for each dollar deposited due to the money multiplier, individual commercial banks are limited by the reserve requirement, which prevents them from lending out several times the amount that is deposited with them.

Step by step solution

01

1. Understanding Multiple Expansion of Bank Deposits

Multiple expansion of bank deposits occurs in a fractional reserve banking system. In this system, banks are required to hold only a fraction of their deposits as reserves and are allowed to lend out the remaining amount. As these loans are deposited into other banks, the entire banking system can create new money through the process of lending, deposit taking, and relending.
02

2. Fractional Reserve Banking and the Money Multiplier

In a fractional reserve banking system, the money multiplier determines the total amount of money supply that can be generated from an initial deposit. The money multiplier is the inverse of the reserve requirement ratio, which determines what percentage of a bank's deposits must be held as reserves. If the reserve requirement ratio is say 10%, the money multiplier would be \( \frac{1}{0.10} = 10\). This means that for every dollar deposited into the banking system, up to 10 dollars can be created.
03

3. Lending Capacity of Individual Commercial Banks

Although the banking system as a whole can create multiple dollars for each dollar deposited, individual commercial banks do not have the ability to lend out several times the amount deposited with them. Each bank is subject to the same reserve requirement and must hold a certain percentage of its deposits as reserves. When a bank lends money, it can only lend out the remaining portion of its deposits after meeting its reserve requirement. For example, if a bank has \(100 in deposits and its reserve requirement is 10%, it can only lend out \)90, not several times the deposited amount.
04

4. Conclusion

The statement "Because of multiple expansion of bank deposits, individual commercial banks are able to lend several dollars for each dollar deposited with them" is false. While the entire banking system can create multiple dollars for each dollar deposited due to the money multiplier, individual banks are limited by the reserve requirement, which prevents them from lending out several times the amount that is deposited with them.

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Most popular questions from this chapter

Suppose Mr. \(\mathrm{X}\) has a checking account in Bank A, and Mr. \(\mathrm{Y}\) has a checking account in Bank B. Banks A and B each have \(\$ 100,000\) in deposit liabilities and \(\$ 30,000\) in reserves, and the required reserve ratio is \(20 \%\). Show what happens to each bank's deposit liabilities, reserves, and excess reserves if Mr. X writes a check for \(\$ 10,000\) to Mr. Y, Mr. Y deposits the check into his account at Bank \(\mathrm{B}\), and Bank \(\mathrm{B}\) collects from Bank A.

Suppose a bank acquires an additional \(\$ 1\) of deposits and no required reserve ratio exists. By how much could this one dollar deposit theoretically expand the money supply?

If a bank has total reserves of \(\$ 1000\) and demand deposits of \(\$ 2000\), what is the amount by which demand deposits can expand in the banking system, assuming a \(20 \%\) required reserve ratio.

Suppose \(\$ 100\) is deposited into a bank. If the required reserve ratio is \(100 \%\), what is the demand deposit multiplier and what is the total addition to demand deposits of the banking system resulting from the initial deposit?

Explain why yield curves may slope downward in periods of prosperity and high interest rates; and why they may slope upward in periods of recession.
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