In modern macroeconomics, how is the money supply in a typical fiat monetary system backed?

• A. By a fixed quantity of gold held in reserve that can be exchanged for currency on demand.
• B. By the government's legal authority and the public's confidence that it will be accepted for payments (legal tender and credibility).
• C. By the value of real goods and services currently produced in the economy, guaranteeing one dollar always buys a fixed bundle.
• D. By each bank keeping 100% reserves so every dollar of deposits is fully backed by currency in the vault.

Answer: (B)

Verified step by step guidance

1. Understand that in a fiat monetary system, money is not backed by a physical commodity like gold or silver.
2. Recognize that the value of money in such a system comes primarily from the government's declaration that it is legal tender, meaning it must be accepted for payments within the country.
3. Acknowledge the importance of public confidence and trust in the government's ability to maintain the value and acceptability of the currency.
4. Note that the money supply is not directly tied to the quantity of goods and services produced, nor is it backed by 100% reserves held by banks.
5. Conclude that the backing of money in a fiat system relies on legal authority and credibility rather than physical assets or full reserve banking.