Concept of Money Supply

Concept of Money Supply –

Money supply plays a very important role in the economic growth of a country. Any increase or decrease in the money supply directly affects the rate of economic growth. A proper amount of money supply can accelerate the economic growth but excess of money supply can halt it. The proper management of money supply is very important for the study growth of the economy.

Money Supply –

Money supply is the total stock of money or medium of exchange available to the public for use in connection with the economic activity of the country.

There are two important things about the money supply –

First, the money supply refers to the total sum of the money available to the public in the economy at a point of time. So we can say that the Money supply is a stock concept.

And second, money supply always refers to the amount of money held by the public. The term public includes the households, firms, businesses and institutions other than banks and the government.

There is a difference between the users and producers of the money. Public uses money for different transactional purposes but the banks and the government produces money for the use by the public. The money held by the government and by the banks isn’t used for the transactional and any other speculative purposes and also excluded from the standard measures of money supply.

Money supply has two components –

1. Currency with the Public –

To find the total currency with the public we add

a. Currency notes in circulation issued by the central bank of a country

b. The number of notes and coins in circulation

c. Small coins in circulation

Cash reserves with the banks has to be deducted from the value of the above three items of currency to find the total currency with the public because cash reserves with the banks must remain with them and can’t be used for making payments for goods or any transaction by commercial banks.

All the paper currency and coins are fiat money, which means they serves as money on the basis of the fiat (order) of the government.

In simple terms, on the authority of the government, no one can refuse to accept them as payments for transactional purposes. That’s why they are called legal tender.

2. Demand deposits of the Public with Banks –

Other important component of the money supply is the demand deposits of the public with the banks.

These are held by the public and also called bank money or deposit money. These deposits are mainly of two types – Demand Deposits and Time Deposits.

Demand deposits are those deposits which can be demanded by the public at any time and can be withdrawn by drawing cheques on them. Deposits can be transferred by drawing cheques on them to other for making payments.

Demand deposits are the fiduciary money.

Fiduciary money is the money which functions as money on the basis of trust of the persons who make payments with it rather than on the basis of the authority of government.

Bank deposits are created when people deposits money with the banks. Banks also creates deposits when they give loans to businessmen or other borrowers.

Banks operates on the basis of fractional reserve system, which helps them to create much more credit with the small cash reserves they held.