Question

Define Supply of Money.

Hint:

Central banks carefully monitor the money supply to maintain a balance between promoting economic growth and preventing excessive inflation.

Answer 1

The Supply of Money refers to the total amount of money available in an economy at a particular time. This includes physical currency (coins and paper money), demand deposits, and other liquid assets that can quickly be converted into cash, such as savings accounts and money market funds. Central banks play a key role in controlling the supply of money through various tools, including: 1. Open Market Operations (OMO): The buying and selling of government securities by the central bank to regulate the money supply. By purchasing securities, the central bank injects money into the economy; by selling securities, it absorbs money from circulation. 2. Interest Rates: The central bank influences interest rates, which directly affect borrowing and lending in the economy. Lower interest rates typically increase the money supply by encouraging borrowing and spending. 3. Reserve Requirements: The percentage of deposits that commercial banks must hold as reserves. Lower reserve requirements increase the money supply, as banks can lend more, while higher requirements restrict the amount of money available for loans. The money supply is categorized into different measures: - M0: The total of all physical currency (coins and paper money) in circulation. - M1: Includes M0 plus demand deposits (checking accounts) and other liquid assets. - M2: Includes M1 plus savings accounts and time deposits. - M3: Includes M2 plus large time deposits and other forms of institutional money. A well-managed money supply ensures stability in an economy. If the money supply grows too quickly, it can lead to inflation, where the value of money decreases and prices rise. On the other hand, if the money supply contracts too much, it can lead to deflation, which can result in lower economic activity and higher unemployment. Central banks adjust the money supply to achieve specific economic objectives, such as controlling inflation, fostering economic growth, and ensuring a stable currency.