ECON 2020 Lecture Notes - Lecture 16: Fractional-Reserve Banking, Reserve Requirement, Money Multiplier

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7 Mar 2017
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Amount of money the banking system generates with each dollar of reserves. Banks may hold reserves above the legal minimum. Banks hold only a fraction of deposits in reserve. Increase in reserve ratio means decrease in money supply. Use of borrowed money to supplement existing funds for purposes of investment. Government regulation specifying a minimum amount of bank capital. If bank"s assets rise in value by 5% Because some securities the bank was holding rose in price. ,000 of assets would now be worth ,050. A 5% increase in value of assets. If a bank"s assets are reduced by 5% Because some people who borrowed from the bank default on their loans. ,000 of assets would be worth . Value of owner"s equity falls to zero. Bank would be insolvent, unable to pay off its debt holders and depositors in full. Mortgage loans and securities backed by mortgage loans. Shortage of capital induced the banks to reduce lending.

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