Macroeconomics - exam Essay Example | Topics and Well Written Essays - 1750 words

Macroeconomics - exam - Essay Example The money supply can be influenced through three main tools which the Federal Reserve or the Central Bank of a country will use to either create money or reduce money. These options include 1. Changing the Required Reserve Ratio – Reserve Ratio can be described as the percentage of depositors balances which the banks are expected to have on hand as cash. The Federal Reserve can change this rate depending on whether it wish to reduce or increase money supply. When the ratio is lowered, the banks can lend out more funds, increasing the money supply. Conversely if the reserve ratio is increase, the banks have to lend less and keep more money in the reserves. 2. Chaniging the discount rate or the prime lending rate – at which the commercial banks borrow from the central bank can also create more money or less money. If the prime lending rate is low the commercial banks can borrow more and lend out to the economy which will create more money within the market. 3. Engaging in open market operations - By actively engaging in open market operations such as buying and selling of various credit instruments and foreign currencies or commodities, the Federal reserve can either create or reduce money. Open market operations allow central banks great flexibility in the timing and volume of monetary operations at their own initiative, encourage an impersonal, businesslike relationship with participants in the marketplace, and provide a means of avoiding the inefficiencies of direct controls. To calculate the reserves, the depositors money should be multiplied by the reserve rate stipulated by the Federal Reserve + 100. For example, If reserve rate is 10% and bank has deposits of $1 billion, it is required to have $110 million on reserve. If the bank has 220 billion in its reserve and depositors deposits are 190 billion then to find out the reserve