Central banks use several different methods to increase (or decrease) the amount of money in the banking system. These actions are referred to as monetary policy. While the Federal Reserve Board (the Fed) could print paper currency at its discretion in an effort to increase the amount of money in the economy, this is not the measure used. Here are three methods the Fed uses in order to inject (or withdraw) money from the economy:
- The Fed can influence the money supply by modifying reserve requirements. which is the amount of funds banks must hold against deposits in bank accounts. By lowering the reserve requirements, banks are able loan more money, which increases the overall supply of money in the economy. Conversely, by raising the banks' reserve requirements, the Fed is able to decrease the size of the money supply .
Bank, the Fed is able to effectively increase (or decrease) the liquidity of money. Lower rates increase the money supply and boost economic activity; however, decreases in interest rates fuel inflation. so the Fed must be careful not to lower interest rates too much for too long.
To learn more about central banks and their role in monetary policy, check out Formulating Monetary Policy .
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