Question

(b) Why is it hard for the central bank to control the money supply and why, instead, do central banks increasingly choose to control intermediate targets such as interest rates?

Answer 1

The Federal reserve usually does not directly control the money supply. The Federal reserve indirectly controls
the money supply by influencing the interest rates. The Federal reserve usually undertakes open market operations
to affect the interest rates instead of directly changing the interest rates.
When the Federal reserve buys bonds prices of bonds are pushed higher and interest rates decrease.
The overall effect of buying bonds is a lowering of interest rates and an increase in money supply.
When the Federal reserve sells bonds prices of bonds are pushed lower and interest rates increase.
The overall effect of selling bonds is raising of interest rates and a decrease in money supply.
To sum up, the Federal reserve controls the money supply by influencing interest rates through
open market operations.