Reference no: EM131521307

Money supply in the economy depends on bank's ability to provide the public with funds that enable them to consume and invest. In such, banks are critical component in modern economies, and quantity of money that they hold that are loanable (people can borrow) determines the quantities of consumption and investment, thus, the level of aggregate demand (GDP). However, banks don't "print" money to generate money supply. They (banks) are dependent on monetary policies and regulations set by the Federal Reserve Bank. In addition and since banks are the primary supplier of money to the economy, the government takes the performance of banks as well as other financial institutions seriously since a failure of a banks means a financial failure (loss) for many other individuals and firms in the economy. During the financial crisis that started in 2007, the government bailed out many large financial institutions (including banks) to enable those institutions to continue borrowing and lending.

Discuss the mechanisms in which banks generate money in the economy and what regulations the Federal Reserve Bank imposes that affect the banks' available fund that they can loan to the public.

Also, would you consider too much government involvement in the supply of money a potential source of inefficiency in the economy (moral hazard)? In other words, if banks know that the government will back them up if they fail, could this fact be a motive for banks to take unrealistic risk that might push the economy into a recession?