Chapter 25, Problem 1CYU

To determine

The situation where bank run occurs due to absence of deposit insurance. Also, analyze the change when deposit insurance is present.

Explanation of Solution

If there is rumor about bank failure then being a depositor, it is rational to withdraw the amount before bank fails completely that it could not repay the amount. This will be in the case when there is no deposit insurance.

In case of deposit insurance, a depositor after hearing such rumor will not withdraw the amount as insurance company will pay the amount deposited in the bank even if bank leads to failure. Therefore, in case of presence of deposit insurance, bank run situation will not occur.

Economics Concept Introduction

Federal Reserve System: It is a central bank that looks after the banking system of the country along with the control of its monetary base. Monetary base is the sum of circulating currency and the reserves in the bank.