Answer to Question #300256 in Finance for Mark

Question

Using the knowledge acquired 

in the course (Money and Banking), explain how the Government through the central Bank (Fed) can reduce the inflation rate. (Explain the tools and the transmission mechanisms)

Answer 1

1. Federal Funds Rate: When the Federal Reserve raises its interest rate, banks are forced to raise their rates in response. When banks raise interest rates, fewer people want to borrow money since it is more expensive to do so while the money is accruing at a higher rate of interest. As a result, spending falls, prices fall, and inflation slows.

2. Reserve Requirements: Raise the amount banks are legally obligated to maintain on hand to meet withdrawals by increasing reserve requirements. The more money banks must keep in reserve, the less cash they can lend to clients. Customers will borrow less if they have less money to lend, resulting in lower expenditure.

3. Reducing the Money Supply: The third way is to reduce the money supply directly or indirectly by establishing laws that support money supply reduction. Calling in debts owing to the state and boosting the interest paid on bonds to encourage more investors to buy them are two such examples of this.