Question 1
Banks must hold a certain percentage of their deposits as reserves, known as the reserve requirement. This requirement ensures that banks have enough money to cover customer withdrawals and prevents banks from being overly risky with their lending practices. Requiring banks to hold 100% of their deposits as reserves would be a very conservative approach, limiting the amount of money banks could lend out and likely leading to higher interest rates for borrowers (Shapiro et al., 2023). On the other hand, having too low reserve requirement could make banks more vulnerable to financial crises and bank runs. Finding the right balance between these competing interests is critical to maintaining a healthy banking system (Shapiro et al., 2023). Therefore, requiring banks to hold 100% of their deposits may not be practical. However, the current reserve requirement should be carefully monitored and adjusted as needed to ensure the banking system’s stability.
Question 2
The concept of moral hazard applies to deposit insurance and other bank regulations. Banks that the government insures may become more risk-tolerant since they know they are protected from losses through deposit insurance. It may lead banks to make riskier loans and investments that they would not have otherwise made, potentially leading to a financial crisis (Shapiro et al., 2023). To combat this, bank regulators monitor banks to ensure they manage risk appropriately by requiring regular financial status reports. Banks must meet minimum capital requirements or ratios of capital to assets, which require them to maintain a minimum net worth expressed as a percent of their assets (Shapiro et al., 2023). Capital requirements assure that banks have a sufficient cushion against losses and that they have shareholders or owners with enough at stake to operate the bank prudently. The government also can act as a “lender of last resort” to provide short-term emergency loans in times of financial crisis.
Question 3
The federal government has run a budget deficit for decades, and the budget was briefly in surplus in the late 1990s before heading back into deficit mode. The government has accumulated a national debt, which is the total amount the government has borrowed over time and has yet to pay back (Shapiro et al., 2023). Furthermore, running large budget deficits for long-term investments in human capital and physical infrastructure could build the country’s long-term productivity. I agree with the statement that a balanced budget each year is not necessarily in the best interest of our economy. Although controlling government spending is essential to long-term fiscal stability, balancing the budget yearly would require dramatically cutting essential programs such as Social Security, healthcare, and education.
Moreover, in times of recession, contractionary fiscal policy tends to worsen the problem, and the government deficits increase to help stabilize the economy (Shapiro et al., 2023). It is also essential to distinguish short-term from long-term deficits. Long-term investments in areas that drive economic growth, such as research, education, and infrastructure, can yield benefits far outweigh the cost of increased borrowing.
Question 4
A plan for reducing the government deficit can affect college students, young professionals, and middle-income families in various ways. Suppose the plan includes a reduction in government spending on higher education. In that case, college students may face a reduction in financial aid, leading them to take on more student loans or increase their work hours outside of school ((Shapiro et al., 2023). Middle-class families might also face reductions in government support for healthcare and social services, requiring them to pay more out-of-pocket expenses (Shapiro et al., 2023). On the other hand, if the plan for deficit reduction involves raising taxes, young professionals are likely to be negatively impacted. Higher taxes would decrease their disposable incomes and make it harder to save for the future (Shapiro et al., 2023). In contrast, the effects of deficit reduction through tax increases may be more manageable for middle-income families because the reduced government borrowing power will likely lead to lower interest rates (Shapiro et al., 2023). Lower interest rates mean lower borrowing costs, making it easier for middle-income families to finance their businesses, mortgages, or other major purchases.
References
Shapiro, D., Macdonald, D., & Greenlaw, S. A. (2023). Principles of Macroeconomics 3e.
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