Question

Q.3 Explain the role that the central bank plays in regulating the supply of money.​

Answer 1

If a nation’s economy were a human body, then its heart would be the central bank. And just as the heart works to pump life-giving blood throughout the body, the central bank pumps money into the economy to keep it healthy and growing. Sometimes economies need less money, and sometimes they need more. The methods central banks use to control the quantity of money vary depending on the economic situation and power of the central bank.

• The quantity of money circulating in an economy affects both micro and macroeconomic trends.
• One of the basic methods used by all central banks to control the quantity of money in an economy is the reserve requirement. As a rule, central banks mandate depository institutions to keep a certain amount of funds in reserve against the amount of net transaction accounts. Thus a certain amount is kept in reserve, and this does not enter circulation.
• In most cases, a central bank cannot directly set interest rates for loans such as mortgages, auto loans, or personal loans. However, the central bank does have certain tools to push interest rates towards desired levels.
• Central banks work hard to ensure that a nation's economy remains healthy. One way central banks do this is by controlling the amount of money circulating in the economy. They can do this by influencing interest rates, setting reserve requirements, and employing open market operation tactics, among other approaches. Having the right quantity of money in circulation is crucial to ensuring a healthy and sustainable economy.

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