IN CONCLUSION: WEEK OF NOVEMBER 18th

Recap

By now, you should be somewhat familiar about the role of banks in the economy. They create money through the process of collecting deposits and making loans. These loanable funds represent increases in the money supply and also decreases when they are paid off. Calculating by how much a simple deposit will increase the money supply and checking account balances throughout the banking sector is a straightforward procedure. It requires the use of the required reserve ratio to obtain the money multiplier.

The money creation role of banks is critical in understanding how the federal reserve bank of the United States implements monetary policy. It is the role of the federal reserve to manage the money supply in order to affect the price of money, that is, interest rates. However, that is still not the end result that the federal reserve hopes to achieve. Rather, through lower or higher interest rates, it hopes to stimulate or deter borrowing and thus spending, respectively throughout the economy.

Looking Ahead

In the coming week, you will learn that the federal reserve, through the FOMC, has a few methods of affecting interest rates through the manipulation of the money supply. These methods include control of the required reserve ratio, the discount market for loans and most important, open market operations. These are all the different means to the same end, which is more or less borrowing and spending through lower or higher interest rates, respectively, as a result of managing the supply of money and thus, interest rates.

As you will see, as the federal reserve exercises its tools in controlling the supply of money, the banking system plays its critical role in converting checking account deposits into loanable funds, further increasing the money supply and affecting interest rates.