Example Of Essay On Movement In The Money Supply

Interest rates are pro-cyclical. They rise during expansions or economic booms and fall during recessions or economic contractions. Federal discounting promotes the pro-cyclical movement in money supply to an economy because the spread between the discount rate and the market interest rates rises when there is expansion and declines when there is recession.
In case the interest rates rise during an expansion, it follows that the desired excess reserve amount decreases when there is an expansion. The FED increases interest rates when businesses are experiencing growth in order to steam off inflation. Alternatively, the FED decreases the interest rates when businesses are experiencing slow growth in order to stimulate the economy.
When there is an expansion, the opportunity cost of each dollar that has been kept aside as reserve becomes the interest rates which could have been collected in case the money had been lent out. As such, the more the interest rates rise, the higher the opportunity cost. In order to avoid such a scenario, banks tend to reduce the excess reserves when there is an expansion thereby leading to a rise in the money multiplier. Without there being any other external factors affecting the situation, such as actions by the fed, the increment in the money multiplier leads to an increment in the money supply. In case there is a recession the declining interest rates lower the opportunity cost derived from excess reserves. The banks increase the excess reserves when there is a recession and this leads to the fall of money multiplier.
The movement of money supply might be undesirable because it can add inflationary pressure to an environment that is already experiencing inflation and this can lead to runaway inflation which is extremely detrimental to an economy.