Question Details

GB 540 Unit 5 Discussion 3

The textbook describes how banks “create” money. It also highlights the impacts of this money creation during the periods of inflationary gap and recessionary gap. During the period of a recessionary gap, higher rates of unemployment may be accompanied by lower prices. Banks have a role in the recovery process with their lending roles. 

The modern money is called fiat money. Fiat money is a currency, which is declared by a government to be legal tender. It is not backed by a physical commodity like gold or silver, and it has value solely because a government accepts it for payments of taxes and debts. Fiat money has been an object of serious criticisms ever since its creation. Opponents of the fiat money argue that by not backing up their currency to tangible commodity like Gold, governments facilitate printing of money, which has been proven to generate inflation. 

Based on the above summary and the detailed descriptions of the issues in the textbook (chapter 32) discuss any of the following set of questions:

1.	Explain in your own words the process by which banks “create” money. What is the reserve requirement and what role does it play in money creation?
2.	Discuss the impact of that ability to create money on the economy during an inflationary gap and during a recessionary gap. Considering the higher rates of unemployment and the likelihood of lower prices during a recessionary gap, do banks, with their lending policies, contribute to a recovery?
3.	The only thing backing up a nation- currency (fiat money) in the modern world is faith in the government issuing it. If this is so, what should governments do to maintain a stable currency? How can the Central Bank (the Federal Reserve) build trust in the currency? What actions would undermine a currency?

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