Which of the following statements BEST explains how financial institutions create money?
A) By opening new checking accounts and giving more people access to readily available cash, financial institutions expand the money supply.
B) By issuing money through government contracts, financial institutions expand the money supply.
C) By taking deposits and loaning out these funds, financial institutions expand the money supply.
D) By paying interest on its accounts and investments, financial institutions expand the money supply.
E) By giving interest from its accounts to its clients, financial institutions expand the money supply.

Question

Quizplus · Accepted Answer

Financial institutions create money by taking deposits (which counts as a liability for the institution) and then loaning out those funds to borrowers. This creates new assets for the institution, which can be used to make additional loans or investments, effectively expanding the money supply. This process is known as fractional reserve banking. Option A is incorrect because simply opening new checking accounts does not create new money, it only changes the form in which existing money is held. Option B is incorrect because financial institutions do not issue money through government contracts - this is the responsibility of the Federal Reserve. Option D is incorrect because paying interest on accounts and investments does not necessarily lead to the creation of new money. Option E is incorrect because giving interest to clients does not create new money, it only compensates account holders for money they have already deposited.

Which of the Following Statements BEST Explains How Financial Institutions