In a fractional-reserve banking system, banks create money because:
A) each dollar of reserves generates many dollars of demand deposits.
B) banks have the legal authority to issue new currency.
C) funds are transferred from households wishing to save to firms wishing to borrow.
D) the wealth of the economy expands when borrowers undertake new debt obligations.

Question

Quizplus · Accepted Answer

Banks create money through the process of making loans and accepting deposits. When a bank receives a deposit, it is required to hold a fraction of that deposit as reserves and can lend out the remainder. This creates new money in the form of demand deposits, as the borrower can spend the newly created loan proceeds. Thus, each dollar of reserves can generate many dollars of demand deposits, allowing banks to create money.

In a Fractional-Reserve Banking System, Banks Create Money Because