Question

1. Why does the Fed not have complete control over the nation’s money supply? Who else affects the money supply and how?

2. Milton Friedman believed that the Fed should control the money supply precisely. In the 1960s, he proposed thay the required reserve ratio be raised to 100%.

• How would this policy improve the Fed control of the money supply?

Answer 1

1. The Fed or any central bank in that case cannot control the nation's money supply fully. It is because the Fed is not the only one controlling the money supply. Since there are a number of people in an economy, the amount of money people have as deposits is not controllable by the Fed. along with it the amount of money lent out by banks as loans is not something the Fed can control. Various other things like bonds a person holds or the securities an individual holds are not visible to the Fed.Thus all these factors combined through the channel of open market operations control the money supply along the Fed in the economy.

When people indulge in various such activities they sell and buy assets and thus expand or contract the credit in the economy. All these activities that involve credit creation along with certain duties and policies of the Fed determine the money supply of a nation.

2. Required Reserve Ratio : It is the ratio of deposits that the central bank wants the commercial banks to maintain in reserves and not use in other activities like loan etc.

As proposed by Milton if the reserve ration be raised to 100% then the commercial banks would not be able to loan out amounts to people and hence people would not be able to access money via bank loans. In this way, one source of volatility in money supply is reduced and only deposits made in the banks is controlled by the people. Thus the central bank in this way can have the control of money supply by not letting money flow in the economy to some extent. Thus, the Fed control of the money supply would take place as the Fed now controls the whole deposits in the bank as nothing is lent out by commercial banks.