Financial Institution and Markets

Question 1: Explain critically what monetary tools are used by central banks, such as the Bank of England, the European Central bank and the US Federal Reserve to control the money supply. Explain why central banks cannot fully control the money supply.

Question 2: Discuss critically what will happen to the inflation rate of the countries that join a Monetary Union and adopt a common currency such as the Euro.

Question 1:

Introduction

Money are the essential tools used in our society, the definitions of money can be expressed thru the business point of view is that "... any good that is widely used and accepted in transactions involving the transfer of goods and services from one person to another. In the ancient times, people using goods buying or exchange with other goods which they desired, but slowly they've found out that the expiration of the goods were short, and then they invented using gold or silver as the money for buying the desired goods, as the inconvenience of carrying such heavy gold and silver, and finally they've invented the "paper currency, and metal coins" as the money using in the public for buying and exchanging goods which they desired instead of using gold and silver as the money. Until now, the paper currencies and metal coins are still the only money we are using.

The advantage of using paper currencies is convenient to carry around with us, especially for businessman, they only carry bundles of money to travel around for the business purpose instead of carrying gold and silver. But in the opposite side of this, the control of these currencies has becoming the major problems for the national governments, the money supply contains coins and currency in the hands of the public, controlled by the central bank, and deposits account controlled by the interaction of the households and firms that use money and the banks that create money. The control of supply of currencies are extremely important to a nation's government, it will directly involves the exchanging rate between currencies, and also the value of each currency. here are some of the tools that used by the central banks as the ways of controlling the supply of the money to the market:

Tools of control money supply

(1) Changing Reserve Requirements

Changing reserve requirement can be the best way of controlling the supply of money into the market. To be clear about the reserve requirements, we can make an assumption on this; Banks have thousands of deposit accounts that saved by the public, and each deposit account will only need to maintain 10% of the amounts in the deposit account, which means each $100 in the deposit account, the bank only need to maintain $10 in the account, and the rest $90 may