Answer to Question #64144 in Economics for Daniel

Question

Explain how banks, depositors and the Central Bank influence the monetary creation process. Be sure to include as many features that were covered in your textbook/lectures including the decision-making by the FOMC, the market indicators forecasting a recession, the appropriate policy by the Fed as a countermeasure, describe the dynamics of an open market operation designed to carry out this measure, use graphs of the Federal Funds Market to indicate what is happening, discuss the variables in the money multiplier and input some numbers to show the impact of policy upon the money supply and the incorporate the effect of that monetary creation on Prices and output based upon the monetary equation

Answer 1

The money that banks create isn’t the paper money of the central bank. It’s the electronic deposit money that flashes up on the screen when you check your balance at an ATM. Right now, this money (bank deposits) makes up over 97% of all the money in the economy. Only 3% of money is still in that old-fashioned form of cash that you can touch. Banks can create money through the accounting they use when they make loans. The numbers that you see when you check your account balance are just accounting entries in the banks’ computers. These numbers are a ‘liability’ from your bank to you. But by using your debit card or internet banking, you can spend it as though they were the same as £10 notes. By creating these electronic money, banks can effectively create a substitute for money.