Question

1. Suppose people perceive a greater risk of their local bank closing. How does this alter the money supply? If you were on the FOMC, how would you respond? What risk does this pose?

Answer 1

With the fear of bank run, people will take out all their deposits and currency in circulation will increase while deposits will reduce. this is expected to reduce the money supply because the less money is deposited in banks the less money creation will occur and therefore the money supply will reduce.

The open Market committee can give assurance to the general public that all the deposits in the banks will be insured so that in case of a bank failure depositors will get their money back.

This pose a greater risk because then banks will take unnecessary risk since the federal reserve will be paying off the insured sum of money and banks can use the deposits in any risky venture.