Lesson 7a: Banking and Bank Regulation


 1.  A key to understanding people’s behavior is figuring out the incentives they face.

3.  Inflation (deflation) happens when the money supply grows more quickly (slowly) than output.

ECONOMIC CONCEPTS that support the historical analysis:

 Financial Intermediation

 Commercial Bank

 Fractional Reserve Banking

 Money, the Money Supply, and Money Creation

 Inflation (Deflation)

 Financial Crisis

 Supply and Demand


History Standards (from National Standards for History by the National Center for History in the Schools)

Era 2 – 3:  The student understands how the values and institutions of European economic life took root in the colonies…

Era 8 – 1:  The student understands the causes of the Great Depression and how it affected American society

Era 8 – 2:  The student understands how the New Deal addressed the Great Depression, transformed American federalism, and initiated the welfare state

Era 9 – 1: The student understands the economic boom and social transformation of postwar United States

Era 10 – 2: The student understands economic, social, and cultural developments in contemporary United States  

Economics Standards (from Voluntary National Content Standards in Economics)

Standard 12:  Interest rates, adjusted for inflation, rise and fall to balance the amount saved with the amount borrowed, thus affecting the allocation of scarce resources between present and future uses.

Standard 18:  A nation’s overall levels of income, employment, and prices are determined by the interaction of spending and production decisions made by all households, firms, government agencies, and others in the economy.

Standard 20:  Unemployment imposes costs on individuals and nations. Unexpected inflation imposes costs on many people and benefits some others because it arbitrarily redistributes purchasing power. By creating uncertainty about future prices, inflation can reduce the rate of growth of national living standards.


  • Commercial banks provide financial intermediation – i.e. by accepting deposits and making loans they bring borrowers and lenders together; and they “create” money through the expansion of checkable deposits – i.e. by expanding checkable deposits, they expand the money supply.
  • If banks expand the money supply more quickly (slowly) than real output expands, then inflation (deflation) is often the result.
  • In the process of pursuing a profit-maximizing strategy, banks typically keep only a fraction of their deposits on reserve, hence the expression “fractional reserve banking.”
  • Historically, bank balance sheets were subject to “runs” by depositors.  Because these runs tended to spillover to other banks and thus other sectors of the economy, commercial banks have been a target for regulatory oversight
  • There were major panics in the United States in 1833, 1837, 1839, 1857, 1873, 1893, 1907, and 1930-1933.
  • Bank regulation is typically designed to insure “soundness,” including auditing of bank balance sheets, which for nationally chartered banks is done by the Comptroller of the Currency, and the establishment and maintenance of required reserves, which is overseen by the Federal Reserve System.