Question

“Please type, don't write (except drawing graph).”

Question C1

Describe the two things that limit the precision of the central bank’s control of the money supply and explain how each limits that control.

Answer 1

First of all, central bank cannot control the part of income or liquid currency that households choose to hold in relation to the deposits. If households choose more to hold as currency and less to deposit, then banks reserves to lend will fall. In short money supply will decrease. Secondly, central bank cannot control the money that banks choose to keep as excess reserves. Central bank can demand just the basic reserve requirement. But if banks hold more the basic requirements, the reserve to lend money will be fewer which will inturn decrease the money supply.