Question

Which of the following statements help to explain why, in the real world, the Fed cannot precisely control the money supply? Check all that apply. The Fed cannot prevent banks from lending out required reserves. The Fed cannot control the amount of money that households choose to hold as currency. The Fed cannot control whether and to what extent banks hold excess reserves.

Answer 1

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

Step-by-step explanation:

Every couple of years some congressman (or woman) proposes that the $100 should be eliminated, basically for three main reasons:

1. over 60% of US currency is held overseas
2. the use of cash can be eliminated or reduced through banking services, e.g. debit and credit cards, checks, etc.,
3. only illegal activities actually need $100 bills to move large amounts of money.

Reasons 1 and 3 make it virtually impossible (or impractical) for the Fed to control the money supply in the US. One of the main arguments in favor of reason 2, was that the Fed would increase its control over the money supply, at least the legal money.

Lately, as banks offer more services, the percentage of cash held by households has been decreasing, but as we saw this past weeks with the stock crash due to COVID-19, when something goes wrong, we all run to cash. Everyone started to withdraw all the cash they could from ATMs and banks.

Answer 2

The Fed cannot control the amount of money that households choose to hold as currency

Step-by-step explanation:

As the money supply derives from the the coin and currency amount and the velocity which, is the speed at which the currency is exchanged. When consumers do not want the currency they spend it immediately Thus, they increase the money supply.

The FED can decrease the amount of currnecy in the economy to off-set this when notice but, it is done afterwards

The FED do have hook on the banks therefore it can control the other variable mentioned.