Question

Briefly explain the impact of the introduction of deposit insurance on the money multiplier and money supply. Deposit insurance guarantees depositors can get back all (or most) of their money in bank accounts even if the banks are bankrupt.

Answer 1

Ans- As we know that Deposit insurance guarantees depositors can get back all (or most) of their money in bank accounts even if the banks are bankrupt. The impact on money multiplier and money supply is very obvious. This is because the size of money multiplier depends on the percentage of the deposits. As we know that deposit insurance is a government guarantee to compensate depositors for their losses when a bank fails and if a bank incurs losses and is unable to pay depositors, deposit insurance would pay the depositors. So if a bank fails to give the deposits back, then government have to compensate. Deposit insurance has the capacity to reduce depositor worry and which directly affects bank stability and the ability to create liquidity, since the withdrawal of deposits directly reduces liquidity creation. As a result money supply will fall.