“Checkable deposits” are classified as money because:
they can be readily used in making purchases and payment of debts
they earn interest income for the depositor
they are ultimately the obligations of the Treasury
banks hold currency equal to the value of their outstanding deposits
The Correct Answer and Explanation is:
Correct Answer:
They can be readily used in making purchases and payment of debts.
Explanation:
Checkable deposits are considered a part of the money supply because they function as a medium of exchange, which is one of the primary roles of money in an economy. These deposits—found in checking accounts—can be easily accessed and used by individuals or businesses to make purchases or settle debts using checks, debit cards, or electronic transfers. This liquidity makes them a form of money.
Let’s break down why the other options are incorrect:
- “They earn interest income for the depositor”: While some checking accounts may earn minimal interest, this characteristic does not make checkable deposits money. Earning interest is a feature of certain financial assets like savings accounts or bonds, but it’s not a defining trait of money.
- “They are ultimately the obligations of the Treasury”: This is inaccurate. Checkable deposits are liabilities of commercial banks, not the U.S. Treasury. The Treasury is responsible for issuing currency and managing federal debt, but checkable deposits are managed within the banking system and insured by the FDIC, not backed directly by the Treasury.
- “Banks hold currency equal to the value of their outstanding deposits”: This is not true. Modern banking operates on a fractional reserve system, meaning banks only keep a fraction of depositors’ money in reserve and lend out the rest. If banks held 100% reserves, they wouldn’t be able to lend, and the credit creation process—essential to the modern economy—would not function.
Therefore, the key characteristic that makes checkable deposits money is their immediate usability in transactions, just like physical cash. In monetary economics, this liquidity is critical. Because individuals can use these funds directly to buy goods and services or pay off debts, checkable deposits are included in M1, the narrowest definition of the money supply.