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What is Money Supply?

by Team Goseeko

Money supply refers to the amount of money which is in circulation in an economy at any given time. It is the total stock of money held by the people consisting of individuals, firms, State and its constituent bodies except the State treasury, Central Bank and Commercial Banks.

Professor Friedman defines the money supply at any moment of time as “literally the number of dollars people are carrying around in their pockets, the number of dollars they have to their credit at banks or dollars they have to their credit at banks in the form of demand deposits, and also commercial bank time deposits.”

Determinants of money supply

Size of the Monetary Base

Money supply depends upon the size of the monetary base. Firstly, the monetary base refers to the group of assets which empowers the monetary authorities to issue currency money. secondly, money supply changes with changes in the monetary base.

Community’s Choice

The relative amount of cash and demand deposits held by the people also influences the supply of money. Moreover if the people prefer to make check payments much more than cash payments, the total money supply maintained by a given monetary base would be larger and vice versa.

Extent of Monetization

Monetization refers to the use of money as a medium of exchange. The choice of the community for money as a liquid asset depends upon the extent of monetization of the economy. However if monetization is high, demand for money would be high and vice versa.

Cash Reserve Ratio

The Cash Reserve Ratio refers to the ratio of a bank’s cash holdings to its total deposit liabilities. It determines the coefficient of the credit multiplier. The Central Bank determines the CRR of a country. To sum up, the credit multiplier (m) is the reciprocal of the CRR (r). Therefore m = 1/r.

Monetary Policy of the Central Bank

Monetary policy is the policy of the Central Bank with regard to the cost and availability of credit in the economy. In addition the monetary policy of the Central Bank of any country will be according to the macroeconomic conditions.

Fiscal Policy of the Government

Fiscal Policy is a policy concerning the income and expenditure of the government. Meanwhile the government raises revenue through various sources like different types of taxes, borrowing and through deficit financing, it spends the money raised for various developmental and non-developmental purposes.

Velocity of Circulation of Money

Similarly, Velocity of circulation of money refers to the average number of times a unit of money as a medium of exchange changes hands during a given year. In addition money supply is as total money in circulation V). Therefore higher the multiplied by the velocity of circulation (M velocity of circulation of money, higher will be the money supply and vice versa.

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