Mba 501

Mba 501

  • Submitted By: Kuteyes05
  • Date Submitted: 03/09/2009 2:50 PM
  • Category: Business
  • Words: 1646
  • Page: 7
  • Views: 1

This paper will discuss monetary policy and tools used to control the supply of money, how money is created and factors that influence the decisions made by the Federal Reserve bank to control the economy in terms of a recession. The United States “Central bank”, which consists of all twelve federal banks, is nicknamed the “Fed” (McConnell & Brue, 2004). The Federal Reserve uses the following three tools to control the monetary supply; the discount rate, reserve ratio and open-market structures. The discount rate is the interest rate charged by the central bank to the commercial bank. One function of the central bank is that it is a last resort lender, when a commercial bank has an unforeseen need for emergency funds the Fed will make a short term loan, in return the commercial bank has to sign a promissory note, or IOU drawn (McConnell & Brue, 2004). The commercial bank has to have some type of securities of collateral for the loan, thus allowing the commercial bank the ability to extend credit to the community, allowing the bank the ability to repay their loan to the Fed. The Fed can control the money supply by increasing the discount rate, when a commercial bank lend money borrowed from the Fed to a borrower the money supply is increased. Federal funds rate is the interest paid on such loans that take place overnight on such short notice.
The reserve ratio is another tool used by the Fed, which enables commercial banks the ability to lend money depending on the ratio percentage. The bank must maintain a certain percentage of reserves in order to be able to lend or borrow money. If the ratio is raised commercial banks can eliminate their ability to lend money to borrowers by losing their excess funds, an example of this would be the bank letting a current consumer loan reach maturity without increasing the current credit limit of the consumer, in turn reducing the supply of money (McConnell & Brue, 2004). This method can help the bank meet the Fed...

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