Utilization of Bond market to make and destroy money

How does the FED utilize the bond market to make and destroy money? Which technique do developed countries utilize to decrease the chance of experiencing inflation? What about the Banana Republicans and inflation, do they have this means acessible to them?




The bond market is a frequently used tool for creating or destroying money. When the Fed wants to create money, it purchases the government securities from dealers, so that the dealers’ bank accounts will be credited. The dealers are most probably the banks and when banks have more deposits, they have more to lend to the economy and thus money is created by purchase of bonds by the Fed. Similarly, when the Fed wants to destroy money, it sells government securities to dealers, so that the dealers’ bank accounts will be debited. When banks have fewer deposits, they have less to lend to the economy and thus money is destroyed by sale of bonds by the Fed.

Inflation occurs when the money supply has largely exceeded demand. In order to reduce the chance of experiencing inflation, money supply needs to be lowered or money has to be destroyed and hence the Fed will sell more of government bonds. In this case, the prices eventually drops and interest rates increase thus reducing the chance of experiencing inflation. Banana Republics refer to nations which propose public policies entirely to benefit private corporations for exploiting the public lands and the debts, if any, incurred will be public responsibility. Thus such republics have unstable politicians and hence they do not care for inflation or any such issues. Since Banana Republicans do not concern about public property or the public in general, they certainly do not have any inflationary control measures.

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