Question

How does the Central Bank can decrease the interest rates in the economy using monetary policy?

Answer 1

• Central bank can decrease the interest rates in the economy using expansionary monetary policy tools.
• Expansionary monetary policies are those policies used by the central bank to increase the money supply within the economy.
• These policy tools Increase the money supply and the inflation rates but decrease the interest rates within the economy.
• Commonly used tool by the central bank to decrease the interest rate is the open market operations.
• The Fed performs open market purchase of government securities from the open markets to increase the money supply within the economy. This will increase the inflation rate but the interest rates at a lower level.
• Similarly, it also sets a lower federal funds rate which is the minimum amount of deposits the bank's are required to hold as reserve's.
• A lower federal funds rate will increase the leading activity by the bank which increases the money supply within the economy, thereby decreasing the interest rates.
• It also sets a lower discount rate which is the interest rate a central banks charge other banks or financial institutions for lending them overnight loans.
• Lower discount rate also decreases the interest rate Within the economy.