3 Tools to Change Money Supply:
Open-market operations (buying and selling treasury bonds, notes, and bills).
Discount rate: Interest rate banks are charged when they borrow from the Fed.
Reserve requirement: % of deposits that must be held by a bank as vault cash or on account with the federal reserve.
The Federal Reserve basically uses three tools to affect the supply of money available for the economy. Open-market operations are the most subtle of the three, and consist of the buying and selling of U.S. treasury securities to “gently” increase or decrease the money supply in small increments over time.
The discount rate is the interest rate banks are charged when they borrow from the Federal Reserve. The discount rate can be altered by the Federal Reserve either to encourage or discourage borrowing from financial institutions. A change in the discount rate has a more pronounced affect on the money supply, and is often used to send a clear message to the financial community regarding the Federal Reserve’s intentions to increase or decrease the money supply.
The U.S. practices what is known as “fractional reserve banking.” The reserve requirement is the percentage of some deposits that banks must keep as vault cash, or on account with the Federal Reserve at all times. If you deposit $100 into your checking account, your bank must hold a certain percentage of that deposit in reserve. The rest of your deposit may be used by the bank to make a loan for example.