Banks create money through the a multiplier process. This
happens through a dynamic chain where the bank lend the excess
reserves keeping aside from the deposits it receives. In the next
round this loan is deposited by the borrowers in the bank. Here
again bank sets aside a portion of this deposit as per cash reserve
ratio and lends the excess reserves. This chain develops and ends
only when there are no loanable reserves. These aggregate loans
that the bank lends is the amount of money created.
The three instrument are (i) repo rate (ii) OMO and (iii) cash
reserve rate.
- Repo rate is the rate at which the central bank of Canada lend
the other banks in the country. This imply that if repo rate is
increased this means that the cost of borrowing increases. This has
the effect of reducing borrowing and thus hampers the money
creating process.
- OMO: open market operations is the selling or buying of Govt
securities that impacts the money supply. The selling of govt
securities means that bank of Canada gives away the govt securities
in exchange of money. This reduces the money supply.
- Cash reserve ratio: the cash reserve ratio is the ratio that
the bank of Canada will announce according to which the banks will
keep some cash out of deposits at the central bank. As the cash
reserve ratio is increased the reserves that the bank has to keep
increases and the reserves that are eligible to lend reduces. Thus
an increase in CRR reduces the money supply