Question

Explain the several processes by which the Federal Reserve can increase or decrease the money supply.

Answer 1

Answer:

Monetary policy instruments:

(a) Reserve requirements:

It is the part or portion of the deposits with the banks that have to be kept with the fed. If this reserve ratio increases then as a result money supply decreases because now banks have to keep more funds with the fed.

(b) Open market operations:

It is a monetary policy instrument used by the Federal reserve for controlling the money supply in an economy. When there is a need to increase the money supply then fed purchases the government securities from the public and vice versa.

(c) Discount rate:

It is the interest rate at which federal reserve lends money to the banks. If there is an increase in this rate then banks have to pay higher interest to the fed. This will reduce lending capability of the banks and hence, decreases the money supply.