The questions that I will answer for this week’s assignment are as follows: Why the simultaneous targeting of the money supply and interest rates is sometimes impossible to achieve? How do central banks intervene in foreign exchange markets? What did the Bretton Woods Agreement do to the ability of foreign exchange rates to fluctuate freely?
Targeting Money Supply and Interest rates
Firstly, the Fed targets money supply and interest rates in an effort to control the economy. The mandate of the Fed is to control inflation and maximize employment. Money supply (MS) is controlled by central bank, depositors, borrowers, and depository institutions. The central banks contribution to the determination of the money supply is through the control they have on the monetary base (MB). Monetary base is the currency in circulation plus reserves, both which fall under the central bank’s liabilities but are on the asset side of other banks balance sheets. The importance of the monetary base on the money supply is that when the monetary base is increased, it will increase the money supply. In the reverse, a decrease in the monetary base will decrease the money supply. The Fed controls the monetary base through open market operations. When the Fed purchases securities it, in effect, increases the monetary base, therefore increasing the money supply. With a security purchase, money