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Chapter 17: Q 35. (page 426)

How do bank failures cause the economy to go into

recession?

Short Answer

Expert verified

Bank failures cause the supply of money to reduce because of liquidity shortage.

Step by step solution

01

Step 1. Definition

When a bank becomes insolvent and is unable to meet its obligations to meet its liabilities, this situation is known as bank failure.

02

Step 2. Explanation

In the situation of bank failure, banks run out of liquidity to pay back depositors and other creditors. They are aso unable to extend loans to businesses who in turn faces challenges to raise funds. Lack of funds would affect operations causing decline in production.

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