Question

What tools can the FED use to increase or decrease the money supply. Describe it full. What effect does each tool have on GDP inflation and employment. For example if the Fed increases interest rates what might be the impact of that action on GDP, Inflation and Employment?

Answer 1

Tools which increases or decreases the money supply are as follows :-

1) deficit financing :- it means printing money . Primting more money increase the money supply but at the same printing more of ot make it less valuable , creating inflation . So there are many consequences of priting more money.

2) reserve requirement ratio :- it is mostly used by central banks . As a rule central banks mandate depository institutions to keep a certain amount of funds rserve against the amount of transactions. If central bank wants to reduce the money supply then it will reduce the reserve requirement and vice versa.

3) reverse repo rate :- the central banks sometime borrow money from banks so it interest is charged  on them . If it rises then supply nl money is increases in the economy.

4) interest rates: - central bank doesn't directly set interest rate however use tge moentary tools to push to the desired level.

5) open market operations: - purchase of OPO by central bank causes increase in supply of money in economy and vice versa .