- Interest is very simple. Taylor is assuming that a bank will get its money from people walking in off the street. But if the people on the street want to spend their money on cakes, what will draw them to the bank to deposit their money instead? Answer: Up the interest being paid by the bank to the depositor, until the man on the street hearing about the high interest rate is willing to not eat his cake now, but eat it with interest later.
So the first of the two options in your first q is the right one.
- The problem with FRB exists even if the bank gave no interest at all to the man in the street. They take his money and lend it to Bill Gates for three years, at the same time promising to give it back to the man in the street any time he wants it. Which of course they cannot do, since they lent it all to Gates.
here is how it would look without FRB. Young Bill Gates hits on some brilliant idea. If he scrapes the money together and builds his better mousetrap, he estimates he will get $110 for very dollar he invested. So he goes to the bank and says he wants a loan and is willing to pay 5% interest. The bank, however, doesn’t have any money. So it advertises that if the man in the street will deposit his money with them for say three years [enough time for Gates to pay back his loan] they will give said man on the street 3% interest.