Monetary Policy Tools

and How They Work

Pearl Joy C. Arenas 
Open Market Operations

 Are when central banks buy or sell securities in order to expand or

contract the amount of money in the banking system.

Steps of Open Market Operations

Buying government bonds from banks

 When the central bank of the Country buys government bonds the economy is
usually in the recessionary gap phase with unemployment being a big problem.
 When the central bank buys government bonds it increases the
money supply in the economy.

 The increased money supply decreases the interest rates.

 The decreased interest rates cause consumption and

investment spending to increase and hence the aggregate
demand rises.

 Increased aggregate demand causes real GDP to increase.

Selling government bonds to banks

The central banks sell government bonds to banks when the economy is facing inflation.
The central bank tries to control inflation by selling government bonds to banks.

 When government bonds are sold by the central bank, it sucks the excess money from
the economy. This causes a decrease in the money supply.

 A decreased money supply causes interest rates to increase.

 An increased interest rate causes consumption and investment spending to fall and thus
aggregate demand falls.

 The decrease in aggregate demand causes real GDP to fall.

Reserved Requirement
 refers to the money banks must keep on hand overnight. They can either keep the
reserve in their vaults or at the central bank.

Discount Rate
 It's the rate that central banks charge its members to borrow at its discount window.

Since the rate is high, banks only use this if they can't borrow funds from other
banks.
References
https://www.thebalance.com/monetary-policy-tools-how-they-work-3306129
https://www.stlouisfed.org/in-plain-english/how-monetary-policy-works