How Central Banks Control the Money Supply With Interest Rates

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5 BOOKS THAT INSPIRED THIS CHANNEL

The Narrow CorridorStates, Societies, and the Fate of Liberty

Money Changes EverythingHow Finance Made Civilization Possible

Adaptive MarketsFinancial Evolution at the Speed of Thought

House of DebtHow They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again

The Third PillarHow Markets and the State Leave the Community Behind

Many people think that the central bank primarily controls the money supply (M1, M2, M3). That used to be true. However, since the bulk of money creation is done by private banks, the central bank mainly controls their money creation by setting the short term interest rate (rbi policy rate, rbi repo rate, ecb deposit rate, fed funds rate, Bank of England base rate) on bank loans and on central bank reserves. This video builds on knowledge of how private banks create money. Check that out in my other video here

In most cases, monetary policy boils down to the following. Central bank set the interest rate on which all other rates are based. By doing so they try to control the amount of money circulating in the economy indirectly by making it more or less attractive for commercial banks to lend. Most central bankers change the interest rate as they try to control inflation. They will increase the interest if they believe the economy is overheating. This will lower inflation. They decrease the interest rate to spur the economy to grow faster which will lead to increased inflation.

Monetary policy via interest rates is part of the monetary policy toolkit of central banks. In addition to that central banks can engage in money printing, monetary finance, and quantitative easing. I have separate videos on each of these topics.

Narrated and produced by Dr. Joeri Schasfoort (University of Cape Town)

Timestamps:

If this topic has peaked your interest and you would like to know more about it. I've suggested some excellent readings below:

* Big Debt Crises by Ray Dalio, great book on money and debt by one of the most well known macro hedge fund managers.

* How Global Currencies Work: Past, Present, and Future by Barry Eichengreen, Arnaud Mehl, and Livia Chitu,, awesome book for a more international view.

* Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems by L. Randall Wray, the go to introduction on modern monetary theory.

* Monetary Policy Transmission in a Macroeconomic AgentBased Model by Schasfoort, Joeri; Bezemer, Dirk; Godin, Antoine; Kinsella, Stephen; Caiani, Alessandro (paper), provides an overview of the different channels of monetary policy transmission.

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