Question

what are the three tools the central bank can use to change the money supply? describe how the central bank can use each of these tools to either increase or decrease the money supply.

Answer 1

Open market operations:-

• The fed uses open market operations to either increase or decrease the money supply in the Economy.
• The fed purchases government securities from the open markets in order to increase the money supply in the Economy.
• When fed purchases the bonds , the inflation increases while the interest rates fall and when it sells them, the inflation rate decreases and the interest rates rise.

Reserve Ratio:-

• The Reserve Ratio is the minimum amount of money that must be held by the commercial banks.
• The fed uses Expansionary monetary policy and lowers the reserve Ratio to increase the money supply in the Economy.
• When it increases the reserve ratio , the money supply decreases as the banks lower the amount of loans they lend to people.

Discount rate:-

• The discount rate is the interest rate that fed changes other banks for overnight loans.
• If fed decreases the discount rates, the money supply increases.
• If it increases the discount rate , it raises the price of borrowing and the money supply drops.