Outline the Monetary Policy tools available to Central Banks.  How do they impact the quantity of money and the rate of interest in the economy?  

 

Part A

The monetary tools or policies are

Discount rate.

Reserve requirements.

Open market operations.

Interest on reserves.

Part B

The impact on the quantity of money in terms of expansionary monetary and contractionary monetary policies. Expansionary is when there is money increase and contractionary is when there is money decline within an economy.

Step-by-step explanation

Expansionary policy.

The central bank decides to lower the discount rate so that commercial banks can access more money.

The reserve requirements ratio reduces so that commercial banks can have more money to lend borrowers.

On the open market operation, the Central bank decides to buy bonds and treasury bills so that it can increase money to the economy.

Very minimal interest paid on excess reserves so that Commercial banks can give up and hold their own money.

Contractionary policy.

The central banks increase the discount rate so that commercial banks cannot access money.

Increasing the reserve ratio means the commercial banks will have less to lend, a high ratio increases the reserves requirements by the Central banks.

Selling the government bonds and treasury bills in a form of open market operation cut the money supply within an economy.

A high-interest rate paid on excess reserves triggers commercial banks to increase their reserves to the Central Bank hence they have less to save.

How the Interest rate is then affected.

When the money supply increases through expansionary monetary it means lenders have no choice but to reduce the interest rates so that they can attract more customers/borrowers. Borrowers prefer those commercial banks which offer fewer interest rates, hence when the market for loans increases from the supply side it means the interest rates reduce. When the money supply reduces through a contractionary monetary policy it means commercial banks will charge high-interest rates.