Discussion Post: The Banking System
Overview
From our earlier discussion on economic growth, we know that capital formation (generated through investment) is one of the three main pillars for long-run economic growth. The Financial System, introduced via the circular flow diagram, is a group of institutions in the economy that helps with this effort. Broadly defined, the role of the Financial System in the economy is to facilitate the movement of money from saving to investment. In the U.S. economy, financial institutions can be categorized as financial markets (bond market, stock market) that directly move funds from lenders (saving) to borrowers (investment), or as financial intermediaries (banks, mutual funds) that indirectly move funds from lenders to borrowers.
Gives us a brief look at the banking system (a group of financial intermediaries), and its role in creating money for investment in the economy.
Consider the financial crisis from 2007 to 2009 which was punctuated with a rash of bank failures occurring up to 2014 in the United States. Also consider the banking regulations which were designed to control the money supply while ensuring the safety of depositors' funds. One key observation from the past two decades is that while there were several bank failures, these failures did not lead to runs on banks. In fact, if the government took over a failed bank with liabilities (mostly deposits) of $2 billion (for example), it would pay off the depositors, and sells the assets for $1.5 billion.
Why did these failures not lead to runs on banks? And with the specific example, where would the missing $500 million come from to complete the transaction?
Task
• Review the banking system and the challenges of money creation. The power point slides provided may help.
• As your first post, create a thread addressing the two questions posed above:
o Why the bank failures did not lead to bank runs? And
o Given the specific example, where does the missing $500 million come from?. Since the questions are related, a paragraph summarizing your answers should be sufficient.
The response must include a reference list. One-inch margins, double-space, Using Times New Roman 12 pnt font and APA style of writing and citations.