Answer to Question #235562 in Macroeconomics for Samra

Question

Discuss the process of deposit creation in banks. Explain the effect of Reserve ratio on deposit creation.

Answer 1

The procedure by which the banking system lends excess reserves to establish checkable deposits. The movement of reserves from bank to bank is the money creation process, with each bank using extra reserves to generate loans (and checkable deposits) and holding a portion of the reserves to back up newly made deposits.

The reserve ratio is one of the Federal Reserve's most important monetary policy tools. The Fed may decide to cut the reserve ratio in order to boost the economy's money supply. Lower reserve ratios allow banks to lend more money at lower interest rates, making borrowing more appealing to clients.