Money Supply

[MindFull]

Hello All,

I just wanted to clarify something. When the Gov't conducts an OMO in order to control money supply, the sale of securities will lead to a decrease in the money supply. If the OMO is conducted in order to fund Gov't Spending/Fiscal Expansionary policy, it leads to an increase in the money supply. Bit confused.

Thanks much.

 

[Anna Walklate]

In the first case, you have said that the government wants to control the money supply by selling securities. So the government sells bonds to the open market and in return it gets cash. If that cash is taken out of circulation, then the money supply will decrease (money has been taken from the general public, given to the government and taken out of circulation).

In the second case, you have said that the government wants to fund spending. So as before, it will sell bonds to the open market and in return it will receive cash. If it then spends that cash, the money supply will remain unchanged (money has been taken from the general public, given to the government and then spent, so it's now back with the general public!).

The third possibility is that instead of selling bonds to the general public, the government sells bonds to the central bank and in return it receives cash. Assuming the government then spends that cash, the money supply will increase (new money has been created by the central bank, given to the government and then spent, so there's now more money in circulation).