Percentage in Point

Federal Reserve Tools to Increase Money Supply

Posted: 26 Oct 2010 06:00 AM PDT

To control the money supply in economy, the monetary policy of the US Federal Reserve and the central bank of the US use some exigent tools. These tools are: open market operations, discount rates and fractional reserves, and many other.

Open Market Operations

These are one of the most important tools to increase money supply. These tools are used by the Fed to buy treasury securities that belong to the government that in turn stimulate a gentle increase in money supply in small percentages over a particular time period. Treasury securities comprises of treasury bonds having a life span of ten years whereas the life span of treasury notes consist of two to ten years. Treasury bills mature in one or less than one year and these are the most suitable tool used by the Fed.

money supply

Discount Rate

Discount rates are the second tools used by the Fed to increase money supply. Bank borrows money from the Federal Reserve to perform day to day activities. The interest rates on those loans are called discount rates. The Fed makes small adjustments in these discount rates by sending out a clear message to banks if it wants to increase or decrease the supply of money. Banks are encouraged to borrow more money from the Fed. That borrowed money is then lent to the banks to expand the businesses or for housing loans that result in the increased supply of money in the economy.

Fractional reserves

It is another tool that is used by the Federal Reserve in America to increase money supply. In this tool, all banks and other depository institutions in the county are required to keep certain percentage of their check accounts which are with or without interest as reserves with the Fed. In simpler words, a fraction of deposits are required to be kept as reserve. This adjustment is required to increase the money supply into economy.

Funds Rate

Any change in the Fed funds rates directly affect the short term interest rates such as bank deposits, credit card interest rates, bank loans and the adjustable rate mortgages. The fund rates will be decreased by the Federal Reserve in order to increase the money supply. This activity ends in an overall stimulation of the economy by expanding the businesses, home loans becomes cheaper, and increases the demand for loans.

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