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BUSINESS ECONOMICS - Essay Example

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These can be aimed at either increasing the money supply or tightening the same. There are four conventional ways used by central banks to control money supply. Federal funds rate is the…
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BUSINESS ECONOMICS
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BUSINESS ECONOMICS

Download file to see previous pages... Open market operations involves the buying back or selling of government securities. Of the government wants to increase the supply of money it will buy back the securities it has sold to financial institutions in exchange of currency that will then be circulated in the market in the form of investments or lending. If the government wants to decrease the money supply it will sell its securities and holding onto the money that was previously in circulation. Another way to control money supply is to adjust the rate of lending at which the banks can obtain loans from the central bank or other banks. Higher rate will result in low borrowing and hence tightened money supply and vice versa. Lastly, Cash Reserve requirement is also adjusted in order to control money in circulation. Cash reserve is the amount of funds that the financial institutions are required to keep aside. This is a percentage of the total deposits and higher cash reserve requirement allows banks to lend out less funds. Similarly lower cash reserve requirement enables banks to have more funds to lend out.
Unconventional tools of money supply include the central bank’s commitment to keep rates low in the future. Another means is to adjust the central bank’s assets to provide ease in credit through the change in different rates and prices. Third unconventional way is lower the policy rate to zero by supplying reserves that are more than the required rate (Highered.mcgraw-hill.com, 2011).
Money supply is a crucial aspect that determines the value of currency and inflationary measures. Conventional ways are the standard means for the central bank to control money supply. However, if the economic conditions do not permit the central bank to use the conventional means they resort to unconventional means which are effective but not good for the economy in the long run due to their unpredictable and risky nature.
(b) In a 2012 study the International Monetary Fund (IMF) reported that the fiscal ...Download file to see next pagesRead More
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