If the federal government runs a deficit and borrows from commercial banks,
1) total deposits are not affected
2) total deposits are increased
3) excess reserves are reduced
4) excess reserves are decreased

Question

If the federal government runs a deficit and borrows from commercial banks,​
1) total deposits are not affected
2) total deposits are increased
3) excess reserves are reduced
4) excess reserves are decreased

Quizplus · Accepted Answer

When the federal government borrows from commercial banks, the banks' reserves are used to purchase government securities. This action decreases the excess reserves (4) because the funds that were previously available for lending are now tied up in government securities. However, when these funds are spent by the government, they are deposited back into the banking system, often in different banks, which increases the total deposits (2) in the banking system. This process can lead to a multiplier effect, where the initial deposit leads to a series of loans and deposits that ultimately increase the total deposits in the banking system more than the initial amount borrowed by the government.

If the Federal Government Runs a Deficit and Borrows from Commercial