Monetary policies suggest greater attention over the world by renewed the interest in employing the central banks to control the money supply. Role of monetary policy is important to maintain a low and stable rate of inflation and price stability in the economy.(Rangarajan,1998) Imbalances of the import and export can cause the fluctuation of the exchange rate in the country. Different central bank used different monetary tools to control the money supply and maintain the economic stability of the country.
Monetary Tools Used to Control the Money Supply
1. Bank of England (BoE)
BoE used operational standing facilities (OSF) and interest rate (IR) to control the money ...view middle of the document...
Minimum reserve requirements is used to stabilise money market IR by the averaging provision.(Scheller,2006). A minimum reserve ratio of 2% (Gray,2011) is applies against overnight deposits, deposits and debt securities within a 2 years maturity and money market paper. ECB is able to broaden the range of financial institution to hold reserves at central bank in order to avoid possible disintermediations and its negative effects on bank activity in euroland. (Hann,2002)
3. US Federal Reserve (Fed)
Fed used open market operation (OMO) and discount rate to control the US money stock. OMO is used to influence the supply of bank reserves by simply buying or selling the US government securities. Fed purchase the government securities if they want to expand the money supply and sells it if they want to reduce the bank liquidity and reserve requirements. (Parkin,2010)Bank reserves will be sufficiently reduced to slow down the growth in the produce contraction in the money stock.(Scott,1999) Discount rate is changes to discourage bank borrowing and deposit expansion. Changing in discount rate allows Fed to control the expansion or contracting the money supply. Fed use discount rate as a signal to banks and public by increase signal and decrease signal to tighten and expand the money supply.(Colander,2001)
Difficulties to control the money supply by central banks
Sometimes central bank can principle control the supply of high powered money as the monopolistic supplier, but unfortunately it cannot control the currency deposit and reserve ratio or the velocity of money circulation directly. Adam Smith mentions that quantity of money in circulation no longer depends on the output of gold nor of printed bank notes.(Smith,2009) Government does not longer control the quantity of money, they more concentrate on controlling the demand of money by changing short term interest rate. Long term interest rate will be remain as the district of market force, heavily influenced by expected rates of inflation and by the supply and demand for long term government bonds.(Urich and Wachtel, 1981) Central banks cannot fully control the money supply because the changes in the economy feeds back the money supply and financial markets. The define expansion of money supply leads to lower...