Question

Suppose the Federal Reserve wants to increase the money supply by $200. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to buy $ worth of U.S. government bonds.
Which of the following statements help to explain why, in the real world, the Fed cannot precisely control the money supply?

a.The Fed cannot control whether and to what extent banks hold excess reserves.
b.The Fed cannot control the amount of money that households choose to hold as currency.
c.The Fed cannot prevent banks from lending out required reserves.

Answer 1

Answer: B. The Fed cannot control the amount of money that households choose to hold as currency.

Explanation: If the Federal government wants to control the money supply, they will buy government bonds. For the Fed to pay for the bonds, the Fed will creates money. Its purchase of bonds will put the new money in the hands of the public.

But one thing the federal government cannot control is the amount of money households choose to hold as currency.