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Chapter 10: Problem 4

What does it mean to say that the United States has a fractional reserve banking system?

Short Answer

Expert verified
The United States has a fractional reserve banking system, which means only a portion of bank deposits are backed by actual cash-on-hand, available for withdrawal. Regulations by the Federal Reserve determine the specific fraction. This system allows banks to use the rest of the money to issue loans, thereby adding to the Money Supply and contributing to economic growth.

Step by step solution

01

Definition of Fractional Reserve Banking

Fractional reserve banking is a banking system in which only a fraction of bank deposits are backed by actual cash on hand and available for withdrawal. This is done to expand the economy by freeing capital for lending.
02

Specifics about U.S. System

In the United States, the Federal Reserve (the Fed) sets the reserve requirement, which is the amount of funds that a bank holds in reserve against specified deposit liabilities. This functions as a safeguard against a bank run, where a large number of customers withdraw their deposits because they believe the bank might become insolvent.
03

Expansion of the U.S. Economy

Banks in the United States are able to use the remainder of the deposits to make loans and thereby create new money. This significantly contributes to the economy’s growth.

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Most popular questions from this chapter

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