INTRODUCTION

It has been a useful fiction in the previous chapters to treat the money supply as being entirely determined by the central bank as if the bank notes that it issues were the only medium of exchange. But since much of what we treat as money is a liability of various private banking institutions, it is now time to explore the actual process by which the money supply is made to grow over time and to evaluate the central bank's control over that process. At the same time, the other forces that play a role in the money supply will come to the fore. In particular, it is vital to distinguish between predictable and unpredictable changes in the money supply. From the discussion in Chapters 3 and 4, we know that they have different effects on the macroeconomy. So far, the unpredictability in the money market has been identified in only a very general way; it is now time to be more specific on this issue: Randomness exists both on the demand side and on the supply side.

Control of the money supply by the central bank relies on a fundamental relationship between the liabilities of the central bank, which are called high-powered money, and the liabilities of the commercial banks, which are referred to as private money.