The second tool the Federal Reserve uses is the adjustment of the reserve ratio. The reserve ratio is the ratio of the required reserves the commercial bank must keep to the bank’s own outstanding checkable-deposit liabilities (Brue, 2004, p. 254). By raising and lowering the ratio, the Fed can control how much the commercial banks can lend. For example, if the Fed lowers the reserve ratio, commercial banks will now have more excess reserves allowing them to lend more money to businesses or individuals. Vice-versa, by increasing the ratio, the Fed forces the banks to lend less money due to having smaller excess reserves.
Here we that this window was created for commercial banks to borrow from RBI in certain emergency conditions when inter-bank liquidity dries up completely and there is a volatility in the overnight interest rates. To curb this volatility, RBI allowed them to pledge government securities and get more funds from RBI at a rate higher than the repo rate. Thus, overall idea behind the marginal standing facility is to contain volatility in the overnight inter-bank rates. Rate of
BUSINESS ECONOMICS ASSIGNMENT- 3 Ques. 1)(a)Analyse both the conventional and unconventional tools used by central banks. (a) Meaning of Monetary Policy:- Monetary policy refers to the measures which the central bank of the country takes in controlling the money and credit supply in the country with a view to achieving certain specific economic objectives. These objectives are: 1. Rapid Economic Growth: The monetary policy effects the economic development by controlling interest rates in the economy and its effect.
(The Economist, 2005). This is partly due to the fact that a number of central banks make their decisions based on the actions of other central banks such as the Federal Reserve in the US (Rogoff, 2006). An example of this would be with number of Asian and oil producing countries will stabilize their currencies against the US dollar, which implies that the policies enacted by the Fed can still have an impact on global interest rates. (Fisher, 2006) Suggests that central banks should be conditioned on changes in foreign potential output and questions why, for instance, the output gap is calculated without taking into account the Chinese and Indian economies.
Open Market Operation- the buying and selling of U.S. government securities 2. Altering reserve requirements- the amount of money banks must hold when its customers deposit monies. 3. Adjusting the discount rate- the interest rate charged to commercial banks. As of today the FOMC is changing interest rates to assist in inflation, intrest rates must change in order to make inflation better.
Under a managed float regime, the foreign exchange rate is determined by demand and supply forces in the market but the central bank intervenes when their domestic currency grow too weak or strong. Under unsterilized foreign exchange intervention, the central bank influences the foreign exchange rate by adjusting MB to instigate changes in MS. Increasing MS by buying international reserves induces depreciation of domestic currency whereas decreasing MS by selling international reserves induces appreciation of domestic currency by influencing both nominal domestic interest rate and expectation about future exchange rate. Central banks also engage in a sterilized foreign exchange interventions “when they offset the purchase or sale of international reserves with a domestic sale or purchase. For example, the purchase of $10000 million of international currency by central bank might be sterilized by selling $10000 million worth of domestic government bonds. When engaging in sterilized intervention, there is no net change in MB, therefore long-term effect does not exist on the exchange rate.
This determines whether the base money that the Fed will release should decrease or increase. As stated in the simulation, the Fed also "tries to use the money supply as a lever to keep the economy on the rails". This is not an easy task for it requires very complicated analysis. Influence on Money Supply There are several factors affecting the money supply: spread between the discount rate and federal funds rate, required reserve ratio and open market operations. It is very important to understand that whenever the "DR charged by Fed is lower than the FFR charge by other banks; banks tend to borrow from the Fed.
In contrary, when central bank tightens monetary policy by raising short-term interest rate, banks will typically increase their interest rates by similar or closely related amount. This will reduce inflation and limit the
The credit is given either specifically or by obtaining instruments like treasury bills, offer, business bills, and so on e. Repo Rate and Reverse Repo Rate Repo rate is the interest rate at which national bank gives cash to the banks as loans. Reverse Repo rate is the interest at which national bank gets money from the banks. The increase in the repo rate and decrease in the reverse repo rate will lead to reduction in the cash supply in the economy.
There are two forms of monetary policy, expansionary and contractionary policy. In expansionary policy, the Federal Reserve Bank ("Fed") is used to fight unemployment by lowering its interest rates and to increase the supply of money. In order to do this, the Fed will buy securities, lower the reserve ratio or lower the discount rate. Its purpose is to make bank loans less expensive and more available which increases the aggregate demand, output and employment. In contractionary policy, the Fed will try to reduce the aggregate demand by limiting the supply of money as well raising interest rates to fight inflation.