2. Three tools are available to The
Fed for changing the money
supply:
1. Changing the required reserve ratio;
2. Changing the discount rate; and
3. Engaging in open market operations.
3. The Required Reserve Ratio
• Increase in required reserve ratio,
less loans a bank can facilitate,
causing decrease in money supply.
• Decrease in required reserve ratio,
more loans a bank can make , Thus
increasing money supply.
4. For Example:
• If the required reserve ratio is 20%
and there is excess money supply,
then the Fed will set the required
reserve ratio at 40% then the total
loans a bank can make will be
decreased, from 80% to 60%, which
will cause a decrease in money
supply.
5. 2. Changing Discount Rate:
• Higher the discount rate, less the
borrowing banks want to do. So it will
decrease money supply.
• Lower the discount rate, more
borrowing banks will do, thus there
will be increased money supply.
6. 3. Engaging in open market
operations:
• Issue Government securities to
contract money supply because
when banks buy these , money
comes to Fed.
• Purchase government securities to
expand money supply by paying
money for these securities.
