Monetary system 4

Question 1

The role of the central bank

Answer 1

They can control the money supply directly through the monetary base or indirectly through the reserve-deposit ratio

Question 2

Controlling the monetary base

Answer 2

-Open Market Operations: Purchasing government bonds with new currency increases the monetary base
-Discount rate: Lowering the discount rate (interest rate central banks charge on loans to banks) encourages banks to borrow more reserves, increasing the monetary base

Question 3

Controlling the Reserve-Deposit ratio

Answer 3

-Reserve requirements: Central bank regulations impose a minimum reserve-deposit ratio; lower requirements encourage banks to loan out more, reducing the rr.
-Interest on reserves: Lower interest on reserves discourages commercial banks from holding reserve deposits in the central bank, reducing rr

Question 4

How precise is the control of central banks on money supply?

Answer 4

Not very precise. Household confidence affects currency deposit ratio. Banks often hold excess reserves as a safety buffer, implying rr is higher than set by the set by the central bank. Overall, these affect the money supply, implying it can change without direct influence of the central bank.