How Government controls the money supply?
Money supply includes all the notes and coins in circulation with the public plus the money with banks. It also includes the deposits in banks and building societies. The later is more significant supply of money and is usually the target of Governments monetary policy. The ways through which Government controls the money supply are:
Open market operations
Government usually sells treasury bills and bonds to raise money. Private individuals invest in these bonds and bills in order to get a healthy rate of interest. This reduces the deposits with banks and the money supply.
Variation of legal reserve requirements
Usually, the commercial banks have to maintain a certain percentage of their assets as deposit with the Central Bank. When the Central Bank wants to reduce money supply it will increase the limit of the deposit kept by the banks. The commercial banks are left with less money to lend to their customers.