Question

1) Explain: Who has control of the money supply in the US Economy? What happens to the interest rate if the money supply increases or decreases and the demand for money remains unchanged?

2) What are the "Tools" of the Federal Reserve? How are they used to increase the money Supply? How are they used to decrease the money supply? When would you use these policies?

No less than 150 words each

Answer 1

1.

The money supply in the economy is controlled by the Federal reserve. It determines the supply of money in the economy at any point of time. It used open market operations to control the supply of money if it is in excess of in shortage. These open market operations include trading in securities or government bonds that the Fed buys when the money supply is less and sells when the money supply is more. Also, there are other instruments including interest rates and Statutory Liquidity ratio used for the same purpose that controls the amount that the bank can lend and the interest they charge on these lending. The interest rate in the economy is inversely proportional to money supply. In a situation when the money supply is more, the Fed will intervene to increase the interest rates, and people will prefer to keep their money in bank to earn higher rate of interest also at this high rate, the investment will be low so that the money supply is curtailed. Also, when the money supply is low, and Fed decreases interest rates, the investment will increase and people will also save less because of the low interest and prefer to consume.