Question

According to the fractional reserve financial system, banks are required to hold a certain fraction of the total deposits as cash at the vault or with Federal Reserve. The rest of the deposits, known as excessive reserves could be used to loan out.

How do excess reserve increase money supply? In this process, is there creation of money or also creation of wealth?

Answer 1

The 100 % reserve system does not allow the commercial banks to increase the money. it is the fractional reserve system that helps to generate the money supply in the economic system.

Under the fractional reserve system, banks are required to keep a certain part of deposits as the reserve and rest of the amount is known as the excess reserve, The excess reserve can be lent out by the commercial banks. In this way, while lending out money, a new deposit is created and again the keeping a certain part as the reserve, the rest of amount is again lent out. In this way the money supply is created.

The creating new money does not mean that new wealth is being created. The new wealth will be created when the new assets are generated with help of borrowed moneys from the banks.