Can money supply be completely controlled by Central Bank ?

Traditionally, money supply is assumed to a completely exogenous variable and the Central Bank is assumed to have a complete control over it. However, in reality, money supply is not under such control. Since a part of money supply is created out of the deposits maintained at banks and financial institutions and credit disbursed by them, other players like financial institutions and the public influence the credit creation capacity of the banking system and thereby the supply of money in the economy. 

 1. Public as a Player in Determining Money Supply : 

To understand how public behavior affects money supply, assume that the public does not have much trust in the banking system. This affects deposit mobilization and credit creation of banks.  This, in technical term, reduces the creation of secondary deposits in the banking system which , in turn, reduces the supply of money. Thus, preference of the public for holding cash over bank deposits clearly reduces the supply of money in the economy. Preference for cash, in turn, depends on the income level, rate of interest, financial access and financial literacy, confidence in the banking system and size of the informal economy, among others. Furthermore, these factors determine the decision of the public to keep their cash balance in the form of current/saving deposits or fixed deposits. Such factors are not completely under the control of central bank as such the central bank can not control public behavior thereby controlling the supply of money. 

2. Commercial Banks as Another Player: 

Commercial banks keep reserves at Central Bank to maintain the regulatory cash reserve ratio  and other ratios like SLR. However, they keep extra reserves with themselves to smoothen their payments. The second one is barely under the control of the central bank but is determined by the bank rate on standing liquidity facility, status of inter-bank market, regularity of deposits and withdrawls in the banking system . There factors are also not under the perfect control of the central bank .   

3. Foreign Sources of Money Supply can not be Controlled. 

When foreign reserves in the form of remittances, foreign direct investment, foreign aid and others enter the country, it is ultimately translated into domestic currency and increases the supply of money in the economy.Central bank can not directly control these sources. For instance, export earnings depends on the income level of other countries, remittances depend on the expansion of economic activities in the destination countries. Central bank has a very little role with these flows.


Due to these, money supply is not a completely exogenous variable. Rather, it is partly endogenous. Central bank can partially control it through open market operations and foreign exchange market interventions. Further, it can control the credit creation power of the BFIs through different regulatory ratios like cash reserve ratio (CRR), statutory liquidity ratio(SLR), loan to value ratio(LTV), credit to deposit ratio(CD), among others. From the sources side, Central bank can control its lending to the government, lending to the government enterprises and lending to the banking system.

To sum up, money supply is not a complete exogenous variable as argued by the traditional macroeconomics. It is the joint behavior of the Central Bank, Commercial Banks and the public.
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