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Besides, they also purchase and sell bonds.
Macesich (2000) argues further that money plays a vital role in the economic activities since it virtually makes economic transaction possible. When the supply of cash is higher in the economy, consumers tend to have more money. This in turn encourages spending. On the other hand firms or businesses or ventures respond by increasing either raw materials or production. Because business activities tend to be spread, the demand for labor as well as capital goods increases. Increase in expansion of money supply consequently results into increase in prices more so if the growth of output approaches the limited capacity. At this stage, consumers begin anticipating inflation. However, lenders begin aggravating for higher interest rates to balance the anticipated reduction in the purchasing power while offsetting the loans. The converse is true when money supply subsidizes or the growth rate declines. For instant, Federal Reserve policy plays a crucial role in determining money supply. It does so by influencing its deposits in the bank. They do this by mandating commercial banks to hold part of the deposits that they accept. These institutions comply by either holding cash in the vaults or holding deposits that they make at the Federal Reserve. The Federal Reserve in turn manipulates their reserve by lending cash to banks and changing the discount rate on loans. Therefore, when the supply of money in the economy is high, despite the interest rate target, the central banks tend to device mechanism that are aimed at limiting cash flow in the economy. When this is done, the demand for cash that is apparently at the bank reserves increases. This increase in the demand compels the central banks to stop holding money in the reserves.
Central banks encounter a challenge of policy enforcement in the domestic banking system ...Show more
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It assists not only in controlling inflation as well as stabilization output. Central banks seldom set a fix interest rate number…
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