How do central banks inject money into the economy?

By Chris Gallant AAA
A:

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:

  1. 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.

  2. The Fed can also alter the money supply by changing short-term interest rates. By lowering (or raising) the discount rate that banks pay on short-term loans from the Federal Reserve 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.

  3. Finally, the Fed can affect the money supply by conducting open market operations, which affects the federal funds rate. In open operations, the Fed buys and sells government securities in the open market. If the Fed wants to increase the money supply, it buys government bonds. This supplies the securities dealers who sell the bonds with cash, increasing the overall money supply. Conversely, if the Fed wants to decrease the money supply, it sells bonds from its account, thus taking in cash and removing money from the economic system.

To learn more about central banks and their role in monetary policy, check out Formulating Monetary Policy.

(For a one-stop shop on subprime mortgages and the subprime meltdown, check out the Subprime Mortgages Feature.)

RELATED FAQS

  1. What are some examples of expansionary fiscal policy?

    Learn about expansionary fiscal policy – tax cuts and government spending – that are used by governments to boost spending ...
  2. What are some examples of expansionary monetary policy?

    Learn about expansionary monetary policy and how central banks use discount rates, reserve ratios and purchases of securities ...
  3. How do financial markets react to recessions?

    Learn more about the relationship between recessions and financial markets by identifying the fundamental characteristics ...
  4. What are the differences between a treasury bond and a treasury note and a treasury ...

    Understand what types of securities the government issues, and learn the difference between Treasury notes, Treasury bonds ...
RELATED TERMS
  1. Bond

    A debt investment in which an investor loans money to an entity ...
  2. Deflationary Spiral

    A deflationary spiral is when a period of decreasing prices (deflation) ...
  3. Negative Interest Rate Policy (NIRP)

    A negative interest rate policy (NIRP) is an unconventional monetary ...
  4. Nordic Model

    The social welfare and economic systems adopted by Nordic countries.
  5. Wall Street Journal Prime Rate

    An interest rate that large banks in the United States charge ...
  6. Welfare Capitalism

    Definition of welfare capitalism.

You May Also Like

Related Articles
  1. Investing

    What Has Been Groupon’s Growth Strategy?

  2. Economics

    A Ban On SWIFT Could Hit Russia Where ...

  3. Trading Strategies

    Consider The Season On Trading Day

  4. Stock Analysis

    Government Bond ETFs: Pros and Cons

  5. Economics

    The Economic Impact of Better US-Cuba ...

Trading Center