Answer to Question #290398 in Macroeconomics for Kay

Question

 If the reserve bank wants to pursue a contractionary monetary policy, the bank should 

Answer 1

1.      By increasing the short term interest (discount rate).

Interest rates are a central bank's most important monetary policy instrument. Commercial banks can generally draw short-term loans from the central bank to meet short-term liquidity shortfalls. In exchange for the loans, the central bank charges a short-term interest rate.

To restrict the money supply, the central bank can raise the cost of short-term loans by raising the short-term interest rate. The increase in interest rates will effect consumers and companies in the economy because commercial banks will raise the interest rates they charge their clients.

2.      By raising the amount in the reserve.

Commercial banks must maintain a specified amount of reserves with the central bank and in the bank's vault. A rise in the required reserve amount would lower the money supply of the economy.

3.      By expanding the open market operations (sell of securities)

By selling and buying government-issued securities, the central bank engages in open market operations. The central bank can lower the amount of money in circulation by selling huge amounts of government securities (such as government bonds) to individuals.