The money supply is controlled by the centralbank, therefore, if the money supply increases this will prompt an increase inspending, thus resulting in positive growth in the economy. It uses thediscount rate, open market operation and reserve requirement to either contractor expand the money supply.When the central bank sells or purchasesgovernment securities in an open market, this is known as open marketoperation. When the central bank wants to contract or expand the quantity ofreserves and the money supply, it uses open market operations. The central bankbuys government securities by means of a check, upon clearance of the check,the quantity of reserves that are in the system expands, which decreases theinterest rate making it easier for individuals and business entities to acquireloans. Hence investment will increase, resulting in an increase in the moneysupply and a boost in economic growth. The total amount of deposits that is withinthe bank and the money that is in circulation outside of the bank makes up themoney supply in an economy.
In order to boost economic growth and stimulatespending in an economy, the central bank can decrease its reserve requirement sothat the commercial banks can generate extra deposits by offering loans tobusiness entities and individuals. Hence, this will cause an increase in themoney supply which would result in a decrease in the interest rate and as aresult investment will increase, thus stimulating a boost in the economy.When a commercial bank borrows money from thecentral bank it pays an interest rate which is known as the discount rate.There is an increase in the money supply when the amount of money borrowed bythe commercial bank increases. The money supply and the amount of money being borrowedby the commercial bank can be influenced by the central bank through thediscount rates.
Hence, when there is a decrease in the discount rate thecommercial bank will be motivated to borrow additional reserves thereby causingan increase in the money supply. As a result, loans will be offered at adecreased interest rate by the commercial bank causing it borrowers to increasetheir level of consumption, leading to a boost in economic growth.