Question

What are the three methods used to control the money supply? Give specifics of each.

Answer 1

1.Open Market Operations : It refers to the buying and selling government securities. When central banks wants to increase the supply of money it purchases the government securities from banks. Thus the banks would have more money to give loans. The opposite procedure that is selling the securites to the banks reduces the money available with banks.

2. Reserve Ratio : It is mandatory for depository institutions to keep a certain amount of their funds in reserve with Central Banks. Thus when central bank wants more money in the economy it would lower the reserve ratio and thus the banks would be able to lend more. If central bank wants to reduce the amount of money it would increase the reserve ratio which would result banks to have less money to lend out.

3.Print More Money : Central Banks can control money circulation by printing money. It will not effect the output or production levels however it will become less valuable when supply is high. It can cause an inflanationy situation also.