Explain how money can be created within banking system

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Money plays a vital role in the functioning of an economy. We need money to pay for goods and services or to discharge debt. The banking system holds and transfers money and thereby permits money to perform its vital functions in the economy. So to understand the banking system, one must understand money. The two are inseparable.

(a) Suppose a central bank were to issue $6 billion of additional currency. If the required reserve ratio is 20%, what is the maximum increase in money supply that the additional currency would generate? Assume that commercial banks make all the loans their reserves allow and the public keeps all its liquid assets in depository accounts.

(b) Using your answer to part (a), explain how money can be created within a banking system.

Reference no: EM132065854

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