ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -So the first thing that happens with a decrease in the money supply is that interest rates rise. As interest rates rise, businesses are less willing to invest to borrow for investment spending. And consumers, too, are less willing to borrow to buy cars and homes and so on. Thus spending decreases.

Detailed explanation-2: -A nation’s money supply and interest rates have an inverse relationship. This means interest rates should be lower if there is a higher supply of money in a country’s economy. Conversely, rates should be higher if the money supply is lower.

Detailed explanation-3: -To increase the (growth of the) money supply, the Fed could either buy bonds, lower the reserve requirement ratio, or lower the discount rate. To decrease the (growth of the) money supply, the Fed could either sell bonds, raise the reserve requirement ratio, or raise the discount rate.

Detailed explanation-4: -An increase in the supply of money works both through lowering interest rates, which spurs investment, and through putting more money in the hands of consumers, making them feel wealthier, and thus stimulating spending.