I sometimes answer Yahoo questions/answers and post more complete answers here.
Q. How exactly can the government control money supply? Clearly it’s not a matter of printing more of less money cause most of the time is just a number of a computer somewhere in the world.
A. Obviously this not a simple question but money supply is generally controlled by monetary policy.
That is, internally, despite all external price factors (Things the govt can’t control that affect prices at home), they can control the movement of money through major money tools like the interest rate.
If they sense that the money supply is getting too high (generally a sign marked by a rise in inflation), then they INCREASE the interest rate to decrease the amount of spending.
Literally, when increasing the interest rate investors tend to invest more in government bonds (T-Bills) (rather than say investment of a new factory) so the government gets the money and it can come out of the system.
Simply printing more money doesn’t solve anything, it just goes the way of Zimbabwe where printing currency only pushes inflation higher because nobody is really better off, only prices are higher cause money is worth less (look up purchasing power for more).