Most people say that looking in the past you can see the future, with economics this is true. With the economy in the state that it is in, people will be wondering what they should do and more importantly not do. At the Bank of Green we strive to be the best at what we do and many have voiced their uncertainty about the economy and where it is headed. This report will show you what is happening in the economy and what will most likely happen this coming year. The Federal Reserve still has not met to discuss this but there is a likely course of action that they will take, I will account for this uncertainty. After reading this you should be able to fully understand the ...view middle of the document...
The money supply usually includes currency in circulation and the funds held in demand deposit accounts in commercial banks such as ours. The money supply is very important because of its strong link with inflation. An early 20th century economist Irving Fisher created and explanation for their link. It was coined the Equation of Exchange which said that the total dollars in a country’s money supply multiplied by the number of dollars spent each year will equal the average price of all goods and services sold during the year multiplied with the quantity of assets sold during the year.
The Federal Reserve’s Effects on Money Supply
The Equation of Exchange or the similar macroeconomic Equations for the Demand of Money both are good at showing a link between money supply and inflation, but do not help with economic predictability. This made The Fed rely less on only money supply and more on inflation in order to steer the U.S. economy. In order to adjust inflation The Fed must use its tools to change the money supply accordingly. The three most regularly used processes that The Fed undertakes to change the money supply are Open Market Operations, making changes in the Reserve Requirement and making changes in the Discount Rate. The Fed can adjust the money supply by three things;
1. Open Market Operations
a. Buying Bonds
i. Raises the money supply
b. Selling Bonds
ii. Lowers the money supply
2. Changing Reserve Requirements
c. Raising limit affecting the amount banks can loan out
iii. Lower money supply
d. Lowering limit affecting the amount banks can loan out
iv. Raise money supply
3. Changing the Discount Rate
e. Higher Rate
v. Lower the bank’s willingness to lend money, lowering the supply
f. Lower Rate
vi. Raise the bank’s willingness to lend money, raising the money supply
Open Market Operations and its Effects on Interest
Open Market Operations include selling and buying government securities or other financial instruments. When there is an increase in demand for the amount of money in a country The Fed goes to the open market to buy assets like bonds, foreign currency or commodities (i.e. gold and silver). To pay for these assets they print more cash which is eventually transferred to the seller’s bank and the amount of money in the country is now higher. The reverse scenario would be The Fed selling their financial instruments to the open market. This results in The Fed obtaining money from the buyer and removing that cash value from the economy. These adjustments to the total supply of money in an economy have a direct effect on interest rates. Inflation and interest rates usually tend to be inversely related. The Fed will target and expected inflation rate that they aim for by adjusting the interest rate. If The Fed raises interest rates, inflation is reduced and if The Fed lowers interest rates then inflation...