Reasons why central banks could not fully control the money supply

By | April 22, 2014

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1.1 Reasons why central banks could not fully control the money supply

Through the above tools and also other tools that the central banks could adopt, it is obvious that the central banks could have significant influence in term of controlling the money supply by affecting the availability of cash in the circle, but still the central banks could not fully control the money supply for the following reasons:

1.1.1 Seasonal smoothing of short-term interest rates

One important reason is that the central banks could not fully control the money supply is because in actual scenarios, central banks would not strictly implement the reserve requirements. Based on the view of Richard Werner (2003, p.290) the strict implementation of the reserve requirement changes could actually cause significant volatility in the short-term interest rates which is not desired by the government because it would results instability in the financial system. Hence the seasonal smoothing of short-term interest rates would hence suggests that the central banks could not absolutely maintain the control over the quantity of the reserves that it offers to the banking systems.

1.1.2 Money which central banks have no control

According to Akhand Akhtar Hossain (2009, p.223) the money supply process is a complicated process which could include central bank, commercial bank, the states, borrowers and the depositors, and central banks’ decision are functioning through the responses from other players inside the money supply process, but not all the money will be affected by the central banks’ decisions. For example there could be prepayments as a form of credit with advanced stated interest rates or company’s receivable. Such money is not subjected to the impact of the central bank’s decisions.