Question

Monetary Policy: There are two types of Monetary policies: Expansionary monetary policy and contractionary monetary policy.

Key-Questions:

1. Explain each of the key terms in not more than one or two sentences (give formula or examples whichever is applicable):

(a) Overnight rate of interest (b) Bank rate (c) Money multiplier (d) open market operations.

2. Discuss about the impact of each policy on the supply of money and inflation with suitable explanation and example.

3. Give a graphical explanation of the working of the policy

Sol

Answer 1

A) :-overnight interest rate is defined as the interest rate at which major participants in the money market borrow and lend one day funds to each other

B) :-Bank Rate is defined as the interest rate at which the nation Central Bank provide money to the domestic bank

C) :-Money Multiplier (MM)

It is defined as the ratio of the money supply to the monetary base

It indicates the total number of dollars in the banking system by each additional dollar added to the monetary base

It show for each additional dollar of excess reserves how much will multiply through the economy

Formula for the Money Multiplier

1/reserve ration

Money multiplier

= 1÷rrr

D):-open market operations is defined as the purchase or sale of Treasury securities by Fed in open market

It used to increase or decrease amount of reserves in system

It helpful in influences overall money supply and level of interest rates

All related decisions to it made by FOMC

It show changing amount of reserves in system has multiplier effect on overall money supply, and influences level of interest rates

It usually makes transaction with large investment bank

these purchases and sales are carried out through New York Bank

It most frequently used tool of Fed to conduct monetary policy

Open Market Operations

The Fed purchases/sells securities (bonds) to/from banks