If anybody could help me with these few questions about the money supply, I'd really appreciate it... I think, in principle, I understand the different ways the money supply can be controlled. What I don't understand is the practicalities of how open market operations work. If the central bank wants to reduce the money supply it can sell government securities on the open market. What does the central bank do with the proceeds from these sales? And, conversely, where does it get the money from when it wants to buy back government securities? The investors who buy securities from the central bank will require a return on their investment. Where does the central bank get the extra cash from to provide this return? MxV=PxY. If both inflation and real economic growth are about 2% year on year, and V is constant, M must grow by about 4% each year. How is this achieved without resorting to printing money? I can see how open market operations, adjusting the discount rate, reserve requirements and credit controls can adjust the money supply, but are they really capable of providing sustained growth in the money supply? If money is printed can the government feed it into the economy without increasing government spending or reducing taxes? If the government finances spending by increasing borrowing the LM curve won't move, yet won't the extra demand for borrowing increase interest rates? The ActEd notes say that this moves the IS curve to the right. But isn't this due to the increased aggregate demand from increased government spending, rather than the increased competition for borrowing? Wouldn't an equal injection and increase in demand from, say, increased exports cause the same shift in the IS curve, even though this wouldn't directly affect the demand for borrowing to the same extent? Thanks again for any help.
I got this reply from Anne Walklate at ActEd: "You might imagine that the Central Bank has a big vault underground full of notes and coins that are not in circulation (and so do not count as part of the money supply). Alternatively, it can print new notes. (This is not the same as printing money and releasing it into the system eg through increased government spending, since the new money is used to buy back bonds.) "Printing money" as mentioned in the course notes is really the last resort the government must take if taxation does not meet government spending. Money that is printed by the Central Bank is the method that it uses in order to control the money supply through open market operations – it is not a last resort. This is getting quite technical. I think that all you really need to know is that if the Central Bank sells bonds, there is a reduction in cash in the banks, so banks have to cut back their lending and if the Central Bank buys bonds, there is an increase in cash in the banks, so the banks can increase their lending." Thanks Anne!
I suspect it's a vault full of gold that can be sold to generate more cash for buying back bonds. Although thanks to Gordon, about half our gold is now gone...sold right before the recent bubble in gold prices!
I'm not sure about this! Won't selling gold reduce the money supply because it takes cash out of circulation in exchange for gold? Then buying back bonds transfers the cash back into circulation... hence overall there will be no change in the money supply? (And what has actually increased is the supply of gold) Can anyone confirm this?
