Money supply basics
The following is a dialogue between two economics students who are studying for a test. Assuming that Eileen correctly explains the money supply, fill in the blanks.
CLANCY: I was totally distracted during today's lecture. Did the professor say the narrow definition of money supply is just equal to the amount of currency in circulation plus traveler's checks?
EILEEN: No! The money supply is actually equal to the sum of currency, traveler's checks, and .
CLANCY: And what are those again?
EILEEN: Those are the.
CLANCY: Can the Fed control that?
EILEEN: Well, they can indirectly control it by adjusting the, because that affects the fraction of deposits that banks. The lower it is, the total money the banks can lend out.
CLANCY: And how does that change the money supply?
EILEEN: When you deposit money in your account, your bank can lend it to me. Afterward, counted as part of the money supply.
CLANCY: OK, I think I understand the Fed's role now.
EILEEN: Just remember that the Fed can't completely control the money supply. Banks can choose to hold reserves than the Fed specifies with the reserve requirement. Additionally, preferences for holding money affect the total amount of deposits.