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In a macroeconomics book I'm reading, the author talks about money supply control vs. interest rate control as two different approaches in monetary policy of a central bank.

With the goal of price stability being the same in both cases, money supply control alters the supply of money and thus effects the interest rates within the economy in either a expansive or restrictive manner. With interest rate control, the central bank defines a central interest rate to increase or decrease the money supply for the commercial banks, which in turn translate this into the economy.

The author claims that money supply control is only a viable option when there is certainty about the money demand. Interest rate control is preferred when there is uncertainty about money demand.

I don't quite understand the difference between these two approaches as in my opinion they are essentially the same. They are not even comparable as two different approaches, they are both part of the same approach from my understanding: Interest rate control in consequence effects the money supply. So interest rate control allows money supply control.

In most media you'll only read about how the central banks in the US and Europe alter the central interest rate to increase or decrease money supply. I never read about direct money supply control. I feel like I might be confusing terms or just misunderstand the author.

Can anybody shed light on this topic?

Thank you in advance!

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  • $\begingroup$ I am not entirely sure, anyway: -supply control affect supply of money ,-interest rate moves the demand curve.in other words look at how a LM curve is derived $\endgroup$ – Lex Jun 2 '16 at 18:43
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I think that with money supply control the central bank actively influences The money supply by adding or withdrawing money. By setting the interestrates the central bank influences the lendingcapacity of the banks and the people, lowering the interestrate creates more lendingcapacity and thus 'adds' to the moneysupply... By setting interest rates higher it diminishes lending capacity and thus 'tightens' the money supply..

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Assume a completely open country, that is, import and export of goods and services are unlimited, and capital flows freely from and to it. Assume that the central bank sets a floating interest rate policy: short-run shocks to demand in the liquidity and foreign currency markets influence interest rates (we consider for simplicity that there is a unique interest rate in the country. One may expand this to any number of interest rates) which in turn influence exchange rates. Of course, this permits the central bank to influence the money supply through open market operations (e.g., selling bonds). On the other hand, assuming the main goal of this policy to be price stability, it is the most fitting of the two assuming that demand is more or less stable, because this would permit the central bank to "plan ahead" or not to be caught by surprise by constant variation in demand. The downsides are the risks associated with volatile interest and exchange rates. On the other hand, if the central bank sets a fixed exchange rate policy, this permits to more or less control the equilibrium interest rate, and thus demand, indirectly, which may be desirable if demand is subject to frequent shocks. One main downside is the loss of independence in the monetary policy of the bank. These are both theoretical digressions: in reality, the exchange rate aspect of monetary policy is not black and white. One nice example is the history of monetary policy in Israel after the mid-eighties, where, most relevantly to this question, exchange rate ranges were used.

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