Tools of Monetary Policy Assignment Example | Topics and Well Written Essays - 2500 words

Tools of Monetary Policy - Assignment Example If the required reserve ratio was increased for these big banks they would hold more deposits and lend few. This would not hold the problem at hand as these banks are too big to suffer from search changes (The Editorial Board). The increase would lead rather to a decrease in the money supply and thus the public would suffer as this would lead to an increase in interest rates. Graph 1 The graph above illustrates and demonstrates a decrease in the money supply, which leads to the increased interest rates. An open market operations Open market operation is the buying and selling of government securities in the open market through the Central Bank of a given country. If there is excess money in the economy or rather inflation, and the government wants to reduce this amount, it will sell its securities to the public. The money obtained is used to develop other sectors of the economy or to invest in investments with high returns (The Editorial Board). If, on the other hand, there is little money in the economy, the government will buy these securities from the public to increase money in the economy. To ensure this, the government has ensured that the public has information about these securities and are educated on their importance in the economy at large. Graph 2 According to the graph above increase in money supply (ms) from (Ms0) to (Ms1) the increase, in essence, leads to a decrease in interest rate (r). Interest rate policy For the central bank to control the flow of money in the economy besides bank rate and cash reserve ratio, the central bank can directly influence the economy by increasing or reducing the interest rates. An increase in interest rate causes an increase in money demand, in the economy. This would be the best choice in an economy that wants to favour capital investment. The author is insisting on a change of laws whereas in a free market there are already flexible policies that can aid in protecting the individuals. As illustrated above when t he interest rates are low the people are encouraged to borrow from the bank since it is cheap, when they borrow they use the money to buy bonds, and for other capital investments the central bank interferes by increasing the bank interest rate to reduce the demand for bonds, in essence, the money demand shifts from MD1 to MD2. 2. What role did weak financial regulation and supervision play in causing the 2007-2009 financial crises? Financial regulation refers to the laws and rules that are set by the government of a particular country to govern the financial institutions like the banks and other investment companies. It is majorly done to ensure financial stability in the financial system thus ensuring that funds flow smoothly between investors and savers. This will, in turn, lead to economic growth. The laws also ensure that there is minimized the rate of financial crime by doing away with illegal businesses in the financial system. This has made the public have confidence in the f inancial system since they are sure that their businesses are legal and whatever the returns the get is transparent. Lastly, financial regulation has helped in increasing information to investors, and this has helped in the reduction of both adverse selection and moral hazard problems. A financial crisis takes place when there is a large interference to the flow of information in the financial markets, and this makes the financial system not to function properly.     Ã‚