Question

The existence of multiple claims on a given amount of wealth

Banks have become too big to fail

The relationship between banks and financial markets

The Federal Reserve does not correctly manage the money supply

The underlying economic fragility of the fractional reserve banking system is due to:

The existence of multiple claims on a given amount of wealth

Banks have become too big to fail

The relationship between banks and financial markets

The Federal Reserve does not correctly manage the money supply

Answer 1

The correct answer is: D. The Federal Reserve does not correctly manage the money supply.

Fractional reserve banking is a system in which only a fraction of bank deposits are backed by actual cash on hand and available for withdrawal. This is because the other fraction of the primary deposits are lent further in the process of credit creation. If Federal Reserve does not correctly manage the money supply and there is less money supply than needed, the deposits will rush to the banks to withdraw money for liquidity. This will result in bank runs and the banking system might collapse temporarily since the banks keep only a fraction of deposits at a point in time. Thus the underlying economic fragility of the fractional reserve banking system is due to money supply management by Federal Reserve.