Question

Discuss how banks create money in the U.S., how the Federal Reserve influences money and credit, and how monetary policy affects interest rates and inflation.

"Principles Of Macroeconomics"

Respond to the following in a minimum of 100 words

Answer 1

Banks create most of the money in our economy in the form of bank deposits–the numbers that appear in your account. As banks make loans, they create new money. In today's economy, 97% of the money exists as bank deposits, whereas only 3% is physical currency. The money that banks create is not the paper money with the logo of the Bank of England, which is owned by the government. When you check your balance at an ATM, it's the electronic deposit money that flashes up on the screen. For now, more than 97 percent of all the money in the economy is made up of this money (bank deposits). Only 3 percent of the money you can touch is still in that old-fashioned form of cash. Banks can create money when they make loans through the accounting they use. If you check your account balance, the figures you see are actually accounting entries in the databases of the banks. These numbers are your bank's' liability' or IOU. But you can spend these IOUs using your debit card or internet banking as if they were the same as £ 10 notes. Banks can effectively create a replacement for money by making these digital IOUs.

When it reduces interest rates, the Federal Reserve uses expansionary monetary policy. This is expanding credit and liquidity. It makes the economy grow faster, creating jobs. If the economy grows too much, inflation will be caused. The Federal Reserve is using contractionary monetary policy at this point and is raising interest rates. High interest rates are costly to borrow. Higher borrowing costs slow growth and lower the probability of higher prices for businesses. The Federal Reserve chairs are the main players in the battle against inflation. These are the heads that are managing the interest rates of the Fed.

There are many powerful tools available to the Fed. It sets the requirement for reserve for the banks of the nation. It says banks have to keep at least 10 percent of their deposits on hand every night. For smaller banks, this percentage is lower. The balance can be lent. If at the end of the day a bank doesn't have enough cash on hand, it borrows from other banks what it wants. It's known as the fed funds that it borrows. Banks charge each other for these loans the fed funds rate

In the short term, monetary policy affects inflation and the economy's broad demand for goods and services and thus the demand for the workers who manufacture such goods and services primarily by affecting the financial conditions facing households and firms. The Federal Reserve conducts monetary policy for the nation by managing the level of short-term interest rates and influencing the economy's credit availability and cost. Monetary policy has a direct impact on interest rates; it has an indirect impact on stock prices, income and exchange rates.Short-term interest rate movements also influence long-term interest rates— such as corporate bond rates and residential mortgage rates because these rates reflect the current and expected future short-term rate values, among other factors. Moreover, long-term interest rate movements have an effect on other asset prices, most importantly stock markets and the dollar's foreign exchange value. Of example, everything else being equal, lower interest rates tend to raise stock prices because investors are discounting at a lower rate future cash flows associated with equity investments.