NEW YORK (TheStreet) -- How do central banks inject billions into their economies, and does that money need to be paid back? -- C.P.Central banks look out for the monetary policy of their countries. When a country's economy is in trouble, it is the central bank that can "save" the proverbial day, but how central banks manage that feat is the trillion-dollar question.
What Is a Central Bank?Central banks are responsible for controlling the monetary policy of their countries. Essentially, this means that one of their key jobs is to manipulate the money supply in that country to meet its economic goals (such as market growth). Here in the U.S., the central bank is the Federal Reserve (commonly referred to as "the Fed"). Other important central banks around the world include the European Central Bank, the Bank of England and the People's Bank of China. But you might be wondering why everyone's always on "Fed watch." It's because the money supply really is a big deal. Here's why.
Money Doesn't Grow on TreesMost people will agree that money is a limited resource. While that Lamborghini would definitely make a nice addition to my driveway, I can't really afford the $311,000 price tag. The same is true for the economy -- as a whole, money is scarce. But from an economic standpoint, the scarcity of money doesn't just affect what we're able (or not able) to buy. Factors such as, employment rates and market growth are all affected by the money supply situation. When the economy is hurting, it's often because the money supply is low. One way to counter this is by simply increasing the amount of money, or liquidity, that is present in the economy. Conversely, if the economy is growing too fast (a sign of bad inflation to come) decreasing the money supply is often the Fed's solution. Economists refer to increasing the money supply as "expansionary policy," while decreasing it is known as "contractionary policy." And the Fed has been pretty successful, according to Tim Gindling, a professor of economics at the University of Maryland, Baltimore County. Gindling says, "Since the Great Depression, the Federal Reserve has done a good job using their control over the supply of money to stabilize the economy. The most clear evidence of this is that we have not had a depression since the 1930s." Believe it or not, though, there's more to controlling the money supply than hitting the start button on those machines that print greenbacks. Here's how they go about it.
How Central Banks Control the Money SupplyMethods used by central banks to control the money supply can vary a bit from country to country, depending on the powers that are vested in the central banks. Here in the U.S., there are three main ways that the Federal Reserve is able to alter the money supply:
- Reserve requirements
- Interest rates
- Open market operations