Zemlyanko K.O.

PhD Zhukova O.S.

PhD Petrachkova O.L.

Donetsk State University of Management


A banker would like his money holdings to be reduced to a minimum, since they produce no income.

But there is always an important reason for the banker to hold his money balances at a certain level. The Central Bank makes him hold a certain share of his total balances in reserve. These reserve balances must be in the form of cash or of deposits made by commercial banks with a certain authorized bank. Most of reserve balances are known to be in the form of deposits. Setting the reserve requirements, the Central Bank can regulate money circulation and money supply in an economy.

The Central Bank can, on the one the one hand, increase commercical banks reserves by direct intervention. One way of doing this is by the so-called open market operations: it buys government bonds from the public; thus, the money that goes to the public in payment for these bonds will eventually be deposited with commercial banks, most likely in interest- earning deposits. Having been deposited with a bank, money stops being money, but it represents a net addition to reserve balances capable of supporting loan transactions several times their own value. For this reason, the Central Bank is said to have supplied high powered money to commercial banks.

On the other hand, selling bonds to the public, the Bank can reduce the banking systems reserves and thus make the money supply reduce.

Open market operations are not the only method of direct reserve intervention. Another way for the Central Bank to increase money in circulation is to make loans to commercial banks who in turn lend out to the public the money to be used for daily expenditure.

Finally, the Central Bank can change the money supply without affecting the amount of reserves to be held by commercial banks. It can do this simply having changed the reserve requirement. Having been decreased from 20 percent to 10 percent, the reserve balances will actually double their capacity to support transactions. As a result, maintaining the same reserve balances, banks get a change of handling loan transactions twice as large as before.

Thus, the three monetary policies a Central Bank can implement are as follows:

1. Open market operations.

2. Loans to commercial banks.

3. Changes in reserve requirements.




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