A bank creates money when it:
A) gets new checkable deposits which the depositor formerly held as cash.
B) has a loan paid off, which creates excess reserves for the bank.
C) makes a loan from its excess reserves.
D) holds back excess reserves because of an increase in the required reserve ratio.
E) gets more excess reserves because of a decrease in the required reserve ratio.

Question

Quizplus · Accepted Answer

When a bank makes a loan from its excess reserves, it creates new money. This is because the borrower can then deposit the funds into another account, increasing the overall money supply. Option A is incorrect because it merely transfers existing cash into a deposit account, not creating new money. Option B is also incorrect because paying off a loan reduces the money supply by restoring excess reserves to the bank. Options D and E have to do with changes in the required reserve ratio, which can affect the amount of excess reserves banks hold, but do not directly create new money.

A Bank Creates Money When It