Answer:
It does not change the composition of the money
Step-by-step explanation:
When a person takes $4,000 in cash and places it into a checking account in a bank, it does not change the composition of the money supply, but it does change the size of the money supply. Let's break down the reasons behind these statements:
Composition of the Money Supply:
The money supply is typically divided into different components, such as M1, M2, and M3, based on their liquidity and accessibility. Cash held by the public is included in the M1 component, which consists of currency (physical cash) in circulation and demand deposits (checking accounts). When the person deposits the $4,000 in cash into their checking account, it transitions from the currency component to the demand deposit component of the M1 money supply. So, in terms of composition, the money remains within the M1 money supply, just in a different form.
Size of the Money Supply:
The money supply refers to the total amount of money circulating in the economy at a given time. When the person places $4,000 in cash into their checking account, it increases the overall size of the money supply. This happens because the act of depositing cash allows banks to use a portion of those funds to extend loans and create new money through the fractional reserve banking system.
Here's how it works: Banks are required to hold a fraction of the deposits they receive as reserves, which means they don't need to keep the entire $4,000 in cash. Instead, they can lend out a portion of it while keeping a fraction in reserve. Let's assume a reserve requirement of 10%. In this case, the bank would keep $400 (10% of $4,000) as required reserves and can lend out the remaining $3,600 to borrowers. When this loan is made, the borrower receives $3,600 as a new deposit in their account, effectively increasing the money supply by that amount.
So, by depositing $4,000 in cash, the person has increased the size of the money supply by $3,600 (assuming a 10% reserve requirement). This expansion of the money supply is a result of the fractional reserve banking system and the ability of banks to create new money through lending.
In summary, while the composition of the money supply remains within the M1 component, the act of depositing cash into a checking account increases the overall size of the money supply due to the fractional reserve banking system.