Macro11 Essay Example | Topics and Well Written Essays - 1250 words

Macro11 - Essay Example It is the ratio that banks keep with themselves against the deposits they receive; the bank cannot just lend out all the money it receives. A lesser reserve ratio by the government would mean that the commercial banks have to keep lesser sums of money with themselves and are free to lend out more money into the economy which becomes extended through the effect of â€Å"money multiplier†. If the government’s aim is to reduce inflation it can pump less money into the economy by increasing reserve ratio for which the banks would have to abide by and keep more money with themselves. All the commercial banks lend money from the Central bank (controlled by the government or the government’s bank – at times also referred as the bank’s bank). They have to pay money for this lend money to the central bank, in what our terms we call interest, the banks when borrow from the central bank is called the discount rate. A higher discount rate would lead the banks t o borrow less from the central bank and thereby lending less to the public, which would in turn reduce the money supply in the economy. Conversely, if the federal government decides to increase the money supply, a decreased discount rate would be the option. ... The commercial banks are under the control of the central bank thereby they have to abide by the rules and regulations set by the Central bank. In this tool, there is a market of â€Å"bonds† and â€Å"money† whereby if the central bank wishes to contract the money supply, all it has to do is to print a fancy looking bond and write off an amount in it. Then it sells this bond on the written value to the commercial banks who have to buy the bonds; this reduces their money supply, in making up for their reserve ratio they have to make sure they lend out less as money has flown out of the commercial banking system onto to central bank; this has decreased the money supply in the economy. In contrast, if the federal government wishes to expand the money supply, it would purchase securities (bonds) from the central bank; the buyer gets the money and seller gets a piece of paper (Bond). In this market operation, the commercial bank has excess money to lend out because it has s old a bond, therefore after lending, through a multiplier effect the economy would enhance. This is one of the most commonplace tools used by the governments as it gives an efficient way of allocating money and it convenient without as such delays. The effect can also be forecasted depending on the values of the multiplier. It’s all a study about the state of the economy that will determine the success of any of these tools, but as statistics tell us, this has so far been the most effective tool used by governments today. Answer 2: In case of an easy money policy, the government simply decides to reduce the interest rates: As the interest rate falls from 10% to 8%, there becomes an excess demand for money as we move down the same supply â€Å"S1† curve for money. This excess