Question

What are the techniques available to the Federal Reserve to alter the money supply? Briefly explain how each method works.

Answer 1

There are 3 techniques available to alter money supply:

1) Altering base interest rates: The interest rate charged by Feb to supply money to banks to maintain their reserves. This can be altered - reduced to make the borrowing cheaper for banks and therefore lend more to the consumer/ business and boosting growth or vice versa (rates increased to reduce money supply)

2)Reserve ratio: Its a ratio of deposits of banks held as a collateral with the Fed. If this ratio is increased by Fed, banks need to deposit more money and therefore money in the system reduces and vice versa

3) Open market operations: Refers to buy/sell of government bonds in the market by Fed. If Feb buys securites from market, it increases money supply in the system and vice versa.