HGov: Health Care LPA – Day 2

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You will identify, research, and clarify an issue relating to health care by gathering, using, and evaluating researched information to support your analysis and conclusion.

Econ: Creating Money

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Learning Target: Explain the purpose and functions of money in the banking system.

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The United States banking system uses a fractional reserve system, which means that only a small part of the checking account deposits are actually backed up by cash in the bank vault; banks loan out the rest of the deposits to other customers. This allows the money supply to grow far beyond the amount of physical currency in the country, but it can also result in bank runs if people feel insecure about the bank’s stability. For this reason, the Federal Deposit Insurance Corporation (FDIC) was created to guarantee bank customers’ deposits.

The Federal Reserve sets reserve requirements for banks, requiring banks to hold a certain percentage of deposits in vault cash or on account with the Federal Reserve regional bank. Banks must be careful to avoid loaning so much money that they fall short of the reserve requirement. If they do, they must borrow from other banks overnight to meet the requirement, paying the banks back with interest known as the federal funds rate. When banks make loans, they actually create money.

If the reserve requirement is 20%, when Customer A deposits $1000 into his checking account, the bank must hold $200 in required reserves. The other $800 constitutes excess reserves, which the bank can now loan out to Customer B. Customer B then makes an $800 purchase from Customer C, who deposits that money into her own bank account. As a result, the money supply has increased by $800. But then the bank is required to hold $160 of that deposit in reserve and can re-loan $640 to Customer D, who makes a purchase from Customer E, who re-deposits the funds, creating another $640 in the money supply.

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Homework:
Read Chapter 8.3 (pages 146-150)
Banking System Challenge