Question

Why does the Money supply need to be controlled?

Answer 1

Controlling monetary supply through quantitative easing, which involves instruments such as federal interest rates / interbank loan rates, government bond purchases / sales, and even public-sector spending, can help to keep deflation / inflation levels under control, preventing a currency from being excessively overvalued / undervalued, according to some economic theories.

Controlling a currency's value as regards its exchange rate with other currencies helps to regulate the economy of a nation by influencing the import and export of goods and services. (When a country's currency is strong, the exports to other countries are more expensive and the imports are cheaper the currency is weak)

The Fed's most important tool is the free market activities. It applies to U.S. Government Treasury bonds or bills being bought or sold by Fed. For these types of bonds the "open market" refers to the secondary market. When the Fed purchases open market bonds it will result in an increase in the supply of money. When it sells bonds on the free market, then the money supply will decline.

The money supply increases when the Fed lowers the reserve requirement on deposits. The money supply decreases when the Fed raises the reserve requirement on deposits. The reserve requirement is a Fed regulation that all depositary institutions, including commercial banks, savings banks, thrift institutions, and credit unions, must follow. The law mandates that a percentage of the bank's total reserves of transactions ( e.g., this will include checking accounts but not deposit certificates) be kept as a reserve either as a coin and currency in its vault or as a deposit (reserve) kept at the Fed.