Dynamics of Money Supply

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Money supply is a macroeconomic concept that describes the amount of money available in an economy to buy goods, services. A country or an economic zone’s money relates to the set of values that can be converted into cash, it is the aggregate of cash, bank deposits and debt securities, all of which should be immediately useful as a means of payment.

Data related to money supply is typically recorded and published, by the reserve bank or government. And professional analysts in the public and private-sector make use of such data to evaluate money supply trends and their impact on the economy. The same analysis tools that apply to other markets can be applied to the money market.

Reserve requirements influence the banking industry’s capacity to effect transaction deposits. And goes on to enable the central bank to shape the economy as a whole by increasing or cutting down the reserve requirement.

The main purposes of the reserve system revolve around the stability of money market rates and the increase in structural liquidity shortage in the banking system.

The reserve holds a direct bearing on the liquidity position of banks. An rise in reserve ratios well over the banks’ liquidity, gives rise to a reduction in liquidity. Such minimum reserves assist in influencing the money supply and credit, the reserve is limited by the commercial bank funds. Due to the interest on the reserve, it bears no negative impact on the profitability of banks.

Money is not just about notes and coins, but also bank securities, promissory notes, and checks, etc. Any money held by the public, i.e, banknotes and coins, is associated with the electronic finance system. It is common practice to represent them in the metric system as M0.

A more accurate concept of money supply (M1) comprises notes and coins (M0), plus the intangible balances and the balance of currency deposits. The relationship between money offered as M0 and M1 is the money multiplier, ie, the ratio of cash and money in the pockets of the public and together with daily banking and ATMs total balances.

M2 is M1 plus deposits with terms of less than or equal to two years and deposits with a notice for repayment exceeding three months. M3 consists of M2 plus marketable instruments issued by monetary financial institutions, which represent assets for which the liquidity is high with little risk of capital loss on liquidation (e.g, money market fund, certificate of deposit, debt not exceeding two years). While M4 corresponds to M3 plus treasury bills, commercial paper and medium term notes issued by non-financial corporations.

Banknotes and coins are only a fraction of the currency in circulation, deposit money often represents up to 90%. The central bank produces the currency, commercial banks create bank money by granting loans under the auspices of central banks.

The link between money and prices is attributed to the quantity theory of money, and a solid empirical evidence regards long-term price inflation and money-supply growth. However, the linkage is questioned by some economists indicating money supply is endogenous, and inflation is reared from the distributional structure of the economy.

Monetary aggregates are statistical indicators of homogeneous grouping in the means of payment held by the agents of a given territory. There are several levels of aggregate statistics in the money supply by degree of liquidity.


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