Relate Overnight interest rates targets with money supply
There are many ways to explain the important connection between the overnight interest rate target and the money supply. We will use an example to demonstrate why a decrease in the overnight rate target increases the money supply.
Imagine that the central bank changes the target from 6% to 4%. Before lowering their target, overnight interest rates were at around 6%, say between 5.6% and 6.4%. When the central bank cuts the target to 4%, it signals that it wants to see an overnight rate around 4%.
Remember that central banks normally have standing facilities allowing banks to borrow from the central bank at a rate slightly above the target rate (and to lend at a rate slightly below). If the central bank does nothing except to change the target rate, the banks would immediately use the standing facilities and borrow from the central bank. They were used to borrowing at rates around 6% overnight but can now borrow from the central bank at slightly above 4%. But the central bank does not want the standing facilities to be used - it wants the overnight rate to be close to the target such that the banks lend and borrow from each other in the market. The question then is, how can they influence the overnight market so that banks will want to borrow / lend at around 4%? The answer is by increasing the monetary base and thus the money supply.