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💵principles of macroeconomics review

key term - Demand Deposits

Citation:

Definition

Demand deposits are funds held in bank accounts that can be withdrawn at any time without advance notice. They are a key component of the money supply and play a crucial role in how banks create money through the process of fractional-reserve banking.

5 Must Know Facts For Your Next Test

  1. Demand deposits are considered part of the M1 money supply, which includes the most liquid forms of money in the economy.
  2. Banks are required to hold a certain percentage of their demand deposits as reserves, known as the reserve requirement, which limits their ability to lend out all of their deposits.
  3. The money multiplier effect allows banks to create new money by lending out a portion of their demand deposits, leading to an expansion of the overall money supply.
  4. Checkable deposits, a type of demand deposit, enable account holders to make payments directly from their account balance, facilitating transactions and economic activity.
  5. The level of demand deposits held by the public is a key factor in determining the money supply and the effectiveness of monetary policy tools like open market operations.

Review Questions

  • Explain how demand deposits contribute to the process of money creation through fractional-reserve banking.
    • In a fractional-reserve banking system, banks are required to hold only a portion of their deposits as reserves, allowing them to lend out the remaining funds. When banks make loans, they create new money in the form of demand deposits, which can then be used for transactions and further lending. This money multiplier effect leads to an expansion of the overall money supply, with demand deposits playing a central role in the process.
  • Describe the relationship between demand deposits and the money supply, and how this relationship is influenced by the reserve requirement.
    • Demand deposits are a key component of the M1 money supply, which includes the most liquid forms of money. The reserve requirement, which mandates that banks hold a certain percentage of their demand deposits as reserves, limits the amount of lending and money creation that banks can engage in. As the reserve requirement changes, it affects the money multiplier and the overall expansion of the money supply, with demand deposits being a crucial factor in this process.
  • Analyze the role of checkable deposits, a type of demand deposit, in facilitating economic transactions and the implications for monetary policy.
    • Checkable deposits, a form of demand deposit, allow account holders to make payments directly from their account balance, enabling the flow of transactions and economic activity. The level of checkable deposits held by the public is a key factor in determining the money supply and the effectiveness of monetary policy tools, such as open market operations. Policymakers closely monitor the demand for checkable deposits, as changes in this component of the money supply can have significant implications for the broader economy and the implementation of monetary policy.