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| 1. |
How does a central bank influence credit creation by commercial banks "through open marketoperation '? Expalin |
| Answer» Solution :Central banks affect the quantity of money in circulation by buying or selling government securities through the process known as open market operations (OMO). When a central bank is looking to increase the quantity of money in circulation, it purchases government securities from commercial banks and institutions. This frees up bank assets—they now have more cash to loan. This is a part of an expansionary or easing monetary POLICY which brings down the interest RATE in the economy. The opposite is done in a CASE where money needs to taken out from the system. In the United States, the Federal Reserve uses open market operations to reach a targeted federal funds rate. The federal funds rate is the interest rate at which banks and institutions LEND money to each other overnight. Each lending-borrowing pair negotiates their own rate, and the average of these is the federal funds rate. The federal funds rate, in turn, affects every other interest rate. Open market operations are a widely used instrument as they are flexible, easy to use, and effective. | |