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I understand the fact the Increase in Money Supply reduces the interest rate in Money Market.

But these two explanations are confusing me a lot. I'm not able to understand which is correct.

Reason 1

Let's Say Central Bank Increase Money Supply using Open Market Operation. So, it will buy bonds > Bond Demand Up > Bond Price Up > Bond Interest Down > Money Demand Up till Ms = Md

Reason 2

Due to Increased Money Supply, People are holding more Money they wish in their Pockets. They will use that extra money to Buy Bonds and then the same chain effects as above will follow.

Both the explanations are correct, as far as I think. But which one is ultimately on work? Or are both working (2nd after 1st)?

Please help me in understanding. Thanks in Advace.

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1 Answer 1

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Reason 1 first and then reason 2.

Actually, central bank first decides a target interest rate and then moves the money through OMOs.

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  • $\begingroup$ Thanks for answering. So it's like this? Say, initial int rate = 10. CB wants to target i = 5. With omo, say it comes down to 8 and by by public further down to 5. Am I correct? $\endgroup$ Jul 29, 2022 at 17:40
  • $\begingroup$ yes, it works like this only $\endgroup$
    – stats_geek
    Aug 5, 2022 at 17:43
  • $\begingroup$ Thanks a lot. Finally I am clear now after many days. $\endgroup$ Aug 7, 2022 at 8:12

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