Question

1a. What instruments does the fed use to control the quantity to money ? Explain how a change in each instrument influences money supply.

b. Describe the two things that limit the precision of the feds control.

Answer 1

Answer 1. A. Following are some of the intruments that the federal bank uses to control the money supply in the economy -

• Bank rate- It refers to the rate at which the commercial banks are charged by the central bank for borrowing money from them. Higher bank rate by central bank will lead to high interest rates set by commercial banks and thus people may resist if borrow or invest due to high interest rate. Sometimes to control the liquidity situation in the economy the central bank increases or decreases the bank rates depending upon the liquidity situation in the economy.

•Open market operations- It refers buying or selling of the government securities or bonds in the market by the central bank to control the money supply in the economy. In cases where the money supply is to be increased the frderal bank purchases the government securities thus leading to more money in the economy and vice versa. It is a tool which helps in controlling the money supply in the economy.

Answer b.Two things that are responsiible for limiting the control of fed on the money supply are as follows-

• Lack of securities- As the loans are granted against some charge on assets or aexurities or gaurantees. And it is not always that some has the required and appropriate guarantee against the set loan. This hinders the role of central bank in controlling the money supply in the economy.

• Habit of the citizens- In some countries people have the habit of holding cash and other forms of wealth with them and it leads to less money supply in the economy and thus the central bank is unable to control the credit in the economy. These things are out of the hands of the central bank and thus no policies or procedures are made and can b made to control the habit of people.