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Every Capitalist nation has a monetary system basically similar to ours As a consequence all have developed central banks whose duties are essentially like those of the Federal Reserve namely to exert control over the direction and extent of changes in the money supply The aim of all central banks is also the same They want to keep their economies supplied with the right amount of money If money supplies are scarce the economy will suffer as if it were in a straitjacket Households and business alike seeking in vain for credit from their banks and householders and business alike contracting their economic activity as a result If money supplies are too large householders and businesses will find themselves with larger bank accounts than normal and will be tempted by their liquidity or by the low interest rates offered by their banks to increase their spending This would seem to make the task of the Federal Reserve rather easy All it has to do is to take the temperature of the economy and adjust the amount of money accordingly If the economy is overheated with inflation or worsening clearly it is time to cut back on the availability of money If the economy is in a depression with unemployment rising just the contrary must be the proper course It sounds therefore as if the job of the central banker is an easy one As we shall see it is not How does a central banker increase or decrease the supply of money The key lies in the fact that we have a fractional reserve system in which banks can make loans or investments with excess reserves Excess reserves are simply cash or deposits at the Fed that are greater than those required by law to back up their customers deposits Essentially the Federal Reserve is a system designed to raise or lower the reserve requirements from its member banks When it raises the reserves it
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