Money or the high powered money enters into the economy through country’s banking system, viz., the central bank and the commercial banks. Banks are required to invest a certain part of their funds (deposits) in the Government securities.
Whenever the central bank wants to expand money supply, it enters the market buys back the Government securities from the banks and other individuals and institution that hold these securities. The sellers of the Government securities, viz., the banks and institution are paid by the central banks in money. So, the money stock with the banks increases. The other institutions and individuals who have sold securities, too, deposit their newly acquired money with their banks. Thus, bank’s fund increases, out of which they lend more, create more credit and add to money supply in the market.
The central bank gets high powered money into the economy simply by buying securities (usually government debt instruments). It pays for those purchases with newly issued high powered money. When the central bank wants to reduce high powered money, it sells securities and gets money from the public. This withdrawal of money from the market reduces the volume of high power money.SUBMIT ASSIGNMENT NOW!