Question

Explain how the Central Bank can use monetary instruments to increase employment in the economy?

Answer 1

Ans) Central bank uses expansionary monetary policy to increase the money supply. Increase in money supply increases aggregate demand. To meet those demands, firms respond by increasing production. To produce more goods, more people will be needed. As a result, employment will increase.

In expansionary monetary policy, central bank reduces reserve requirement. By decreasing reserve requirement, bank's excess reserves increases, which they can use to give loans at lower interest rates. When loans increases, aggregate demand will also increase. And thus, output will increase and unemployment will decrease (or employment will increase).

Similarly, central bank can also reduce discount rate, which will allow banks to give loans at lower interest rates and thus increasing aggregate demand.

Central bank can also use open market operations, where it can purchase government securities. By purchasing government securities, more money will be available with the banks as excess reserves. This can be used to advance loans at lower interest rates. This will increase aggregate demand and hence employment.