The Tools That Are Used By the European Central Bank (ECB) To Increase the Money Supply in the Economy - Essay Example

EUROPEAN CENTRAL BANK Question 1 In every country, there exists a situation whereby there is a decrease or an increase in the money supply. This could be due to the changes in the interest rates, inflation, etc. But, as a result, every country must be able to fight and reduce the situation to a healthy economy. There are different factors or tools that exist that can be used to fight the situation. Listed below are the tools that are used by the European Central Bank (ECB) to increase the money supply in the economy. Buying Securities through Open Market Operations The European central bank may use buying securities as a tool to increase the money supply in the euro area (Black, 1986 p. 203). This is through the open market operations. The ECB may affect the supply of money through selling or buying the European government securities, by the use of open market open market operations. When the ECB purchases the government securities from the general public, it will do so using the money that was not in existence in the system. This will make the bank reserves to increase or rise and in turn will make the money supply to increase. For example, when the European Central Bank has an open market operation through buying or selling government securities and when it purchase these government securities from the public, it does so using nonexistent money. Consequently, this makes the reserves in the bank to rise, and as a result this increases the supply of money (Mceachern, 2009 p. 355). Lowering the Rate of Reserve The European central bank may increase the supply of the money by making the reserve rate to be lower (Mcnamara, (1999 p. 67). The ECB can do this through the formulae of the Required Reserve Ratio. Through this ratio, banks are able to know the required and specific amount which they must hold as the reserve through all the deposits and have limits to the amount that the banks will lend out to its customers. If this ratio is increased by the ECB, the money deposits will have to be few, therefore further limiting the amount available to the public Decreasing Discount Rate The European Central Bank may decrease the discount rate so as to increase the money supply. For example, banks may have to borrow funds when they need them. If the banks borrow from the ECB, an interest rate will be paid which is known as Discount rate (Mankiw, 2006 p. 594). Publishing More Money Another tool that can be used by the ECB to increase the supply of money in the economy is the publishing or producing of more money. Though the ECB may decide to increase the money supply in the economy through selling of securities to the public, majority of the public prefer hoarding money thus the money in circulation becomes less. It is for this reason and may be less availability of money that the ECB may decide to publish more money to increase the money supply in the economy (Black, 1986 p.60). Question 2 The ECB expanded asset purchase program was put in place chiefly for the purpose controlling the inflation rate. This was so because the majority of the countries (19) using the Euro as their currency were to encounter the risk of instability in the economic growth as a result of this inflation. Thus, the European Central Bank decided to supplement its monetary policy by the broad expansion of the asset-buying program. The program was to purchase some of the assets that were owned by the economy. Those assets were mainly the securities that the financial organizations hold and own. Consequently, the program had some effects; below are some of those effects/consequences. First, the main consequence as a result of this program was the increase in the assets value that was left in the market for sale and also the injection of liquid capital in the economy. As a result of the asset purchase program, the ECB purchased some of the assets that were owned and held by the financial institutions thus taking ownership of the assets from the public hands into the ECB hands. What this meant was that, the assets now became owned by the ECB, but the money was left to public for circulation. An increase in liquid money in the economy means that the people’s purchasing power will increase thus they will have more money to purchase. The prices of other assets will also increase due to the demand. When the demand for assets increased due to the high purchasing power owned by the public, the price value of the assets also increased. Secondly, the asset purchase program has led to disagreement between ECB and other countries that use the Euro as their currency (International Monetary Fund, 2013 p. 105). This was because majority of the countries that use the Euro currency felt that the program would not be effective enough to solve the crisis that was already affecting them. For example, the head of central bank of Germany voiced criticism that was against the program. He claimed that the body was not fully contented by the program because they felt the result would be certifying as such. However, according to the ECB, the benefits were much greater only if the countries that were opposing them would support the program. The ECB was for the position that as a result of this program the interventions scope and monetary impact amplification would broaden(International Monetary Fund, 2013 p. 105). Thirdly, it was the increase in investment activities (Le Leslé, 2012 p. 24). The main purpose for the program, as stated above, was the controlling of the rate of inflation. Most of the investors would rather invest in regions where the rate of inflation is highly controlled, and they would not incur losses due to such. Thus, when the program was put in place, the rate of inflation was controlled because the assets were purchased. As such, more funds were left for the public to use leading to the increase in prices of goods. Therefore, the inflation rate was stabilized through increasing it in a small amounts. Conclusion In conclusion, it is clear that the ECB plays a very important role the European Countries. Some of these roles are fully supported by these European countries while others are not. In this paper, we have covered one of the tasks that the ECB performs, and this is the controlling of the money supply. In the first question, we discuss the tools that are used by the European Central Bank (ECB) to increase the money supply in the economy of the Euro areas. They include: Buying securities on the open market, lowering the rate of reserve, decreasing the rate of interest and publishing of more currency. In the second question we discuss some of the consequences of the program that was initiated by the European Central Bank, it was known as the asset purchase program. Though the program received some opposition from groups such as the Germany’s central bank, the results were more positive than negative. They included, control of the rate of inflation, increase in the prices of commodity as a result of the increase in purchasing power. Reference List Black, R. D. C. 1986. Ideas in economics. Totowa, N.J., Barnes & Noble Books. De Menil, G. 2010, Economic policy 62. UK, Blackwell Pub, Chichester, West Sussex [http://public.eblib.com/choice/publicfullrecord.aspx?p=589259]. International Monetary Fund, 2013, Global Financial Stability Report, April 2013 Old Risks, New Challenges. Washington, D.C., International Monetary Fund. [http://proxy.library.carleton.ca/login?url=http://www.elibrary.imf.org/view/IMF08/201839781475589580/20183-9781475589580/20183-9781475589580.xml]. Le Leslé, V. 2012, Bank debt in Europe are funding models broken? International Monetary Fund, Washington, D.C. [http://public.eblib.com/choice/publicfullrecord.aspx?p=1607116]. Mankiw, N. G., & Taylor, M. P. 2006, Economics, Thomson, London. Mceachern, W. A. 2009. Macroeconomics: a contemporary introduction. Thomson/South-Western, Mason [Ohio]. Mcnamara, K. R. 1999. The currency of ideas: monetary politics in the European Union. Cornell Univ. Press, Ithaca, NY. Read More