Theory question 107
Financial Institutions(a) Explain how the Central Bank controls money supply through the use of: (i) open market operations; (ii) bank rate.
(b) Outline four functions performed by the Central Bank of your country.
Show the model answer
(a)(i) Open market operations: to reduce money supply the central bank sells government securities to the public and banks, taking cash out of the system and reducing banks' ability to lend; to increase money supply it buys securities, releasing cash.
(ii) Bank rate: the rate at which the central bank lends to commercial banks; raising it makes borrowing dearer throughout the economy, so credit and money supply fall; lowering it does the opposite.
(b) Any four: issues currency; banker to government; bankers' bank; lender of last resort; controls money supply and credit; manages the national debt; manages foreign reserves and exchange rate; supervises banks; advises government on monetary matters; clearing house.
Selling securities and raising the bank rate both reduce money supply.