Question

Why does the Fed want to control the money supply?

Answer 1

Today the Fed is using its resources to monitor the money supply to help the economy stabilize. When the economy slumps, the Fed increases the money supply to stimulate growth. Conversely, the Fed reduces the risk by reducing supply when inflation is threatening. While the Fed's "lender of last resort" mission is still important, the role of the Fed in managing the economy has grown since its inception.

An increase in money supply works both by lowering interest rates, which spur investment, and by putting more money into consumers' hands, making them feel wealthier, and thus stimulating expenditure. Business companies are responding to rising sales by ordering more raw materials and increasing production. The distribution of economic activity increases labor demand, and the demand for capital goods rises. In a buoyant economy, stock market prices are rising, and businesses are issuing equity and debt. If the supply of money continues to expand, prices start to increase, particularly if growth in production exceeds capacity limits.

Money aggregate growth rates appear to be moderate and steady, but as with most central banks, the Federal Reserve now lacks money aggregates in its structure and practice. One possibly unintended result of its success in controlling inflation is that aggregates of money have no predictive power over prices. The lesson the history of money supply teaches is that it is to court monetary chaos to disregard the importance of the changes in money supply. Time can say if the new monetary nirvana is lasting and that lesson is a challenge.