What are tools a central bank can use in a limited reserve economy? (4.6)
(A) Discount Rate
(B) Open Market Operations
(C) Required Reserve Ratio
(D) Quantitative Easing
A, B, and C are correct.
Answer (2)
In a limited reserve economy, a central bank can use the Discount Rate, Open Market Operations, and Required Reserve Ratio as primary monetary policy tools. These instruments help manage the money supply, influence interest rates, and stabilize the economy. Quantitative Easing, while effective in certain situations, is not a traditional tool for a limited reserve economy.
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In a limited reserve economy, a central bank can use several tools to influence monetary policy and manage the economy. These tools include:
Discount Rate:
The discount rate is the interest rate charged by central banks to commercial banks for short-term loans. By altering the discount rate, a central bank can influence the cost of borrowing and lending in the economy.
If the central bank lowers the discount rate, it becomes cheaper for banks to borrow money, often leading to increased lending to businesses and consumers. Conversely, raising the discount rate makes borrowing more expensive, which can reduce spending and slow down the economy.
Open Market Operations (OMOs):
Open market operations involve the buying or selling of government securities by the central bank. This tool is used to control the money supply and influence interest rates.
When the central bank buys securities, it injects money into the economy, increasing the money supply and typically leading to lower interest rates. Selling securities has the opposite effect, reducing the money supply and potentially raising interest rates.
Required Reserve Ratio:
This is the fraction of deposits that banks must hold in reserve and not lend out. By setting this requirement, the central bank can directly control how much money banks can create through lending.
Lowering the reserve requirement allows banks to lend more, increasing the money supply. Increasing the reserve requirement restricts the ability of banks to lend, thus reducing the money supply.
These tools help central banks influence economic factors like inflation, employment, and economic growth. By carefully managing these levers, central banks aim to maintain a stable economic environment.
The correct answer choices, based on the tools mentioned, are (A) Discount Rate, (B) Open Market Operations, and (C) Required Reserve Ratio.
