Question

Monetary authority

            Give the arguments for having one central monetary authority.

            Who (what) puts money in or pulls money out of the US Economy?

            How do they do this?

            How is money created?

            Explain the money multiplier.

Answer 1

Monetary - The word itself means money terms.

A transaction that can be converted into money value will be recorded in the books of accounts but for that an authority is required.

So, A monetary authority is the entity which controls the money supply of a given currency, often with the objective of controlling inflation or interest rates.

The entity (typically the central bank) given the authority by the government or parliament to control money supply by raising or reducing interest rates, oversees exchange rate policy and usually also supervises the banking sector.

As already told that there is one central monetary authority which is argued by many on the basis of -

• Interest rate set by central bank infact is usually set to control economic growth rate and inflation rate keeping them between desired values, so it’s lowered when the economic growth and inflation are low or negative and vice—versa.
• Central banks have unlimited power to print money, is above the law in the sense their financial activities are not audited and they do not answer to the highest political office of the country.

Federal Reserve puts money in or pulls money out of the US Economy.

The Federal Reserve directly controls only the most narrow form of money, physical cash outstanding along with the reserves of banks throughout the country (known as M0 or the monetary base); the Federal Reserve indirectly influences the supply of other types of money. At various times, The Fed creates a “readily liquefiable account” when creating excess bank reserves, so it is also creating money. Since inflation is properly defined as an increase in the money supply, The Fed unquestionably creates both money and inflation when it creates reserves as told earlier.So, By lowering the reserve requirements, banks are able to loan more money, which increases the overall supply of money in the economy.

In open operations, the Fed buys and sells government securities in the open market. If the Fed wants to increase the money supply, it buys government bonds. Conversely, if the Fed wants to decrease the money supply, it sells bonds fromits account, thus taking in cash and removing money from the economic system.

Commercial banks play the important role of ‘money creator’ in the economy. They have the capacity to generate credit through demand deposits. These demand deposits make credit more than the initial deposits. The process of money creation takes place due to the working of the money multiplier. The money multiplier is a constant value by which money multiplies in the economy as a result of an initial deposit. This multiplication of money takes place due to the process of money creation. Thus, money multiplier and money creation process are not the same thing - they are two interrelated, but different concepts.