Demand for Money and Supply of Money

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The demand for money is the amount of money that people and businesses want to hold at a given time. It is a function of a number of factors, including the interest rate, the expected rate of Inflation, and the level of income.

The transactions demand for money is the amount of money that people need to hold to make everyday purchases. It is directly related to the level of income, as people with higher incomes tend to spend more money.

The precautionary demand for money is the amount of money that people hold to meet unexpected expenses. It is inversely related to the interest rate, as people are more willing to hold money when interest rates are low.

The speculative demand for money is the amount of money that people hold to take advantage of expected changes in the price of assets. It is directly related to the expected rate of inflation, as people are more willing to hold money when they expect inflation to be high.

Supply of Money

The supply of money is the total amount of money in circulation in an economy. It is determined by the central bank, which can increase or decrease the supply of money through open market operations.

Open market operations are the buying and selling of BondsGovernment Bonds by the central bank. When the central bank buys government bonds, it injects money into the economy. When the central bank sells government bonds, it withdraws money from the economy.

The central bank uses open market operations to control the money supply and interest rates. By increasing the money supply, the central bank can lower interest rates. By decreasing the money supply, the central bank can raise interest rates.

Money Multiplier

The money multiplier is a measure of how much the money supply can increase when the central bank injects money into the economy. It is calculated by dividing the money supply by the monetary base.

The monetary base is the total amount of money that is directly controlled by the central bank. It includes currency in circulation and bank reserves.

The money multiplier is greater than 1 because banks are allowed to lend out a multiple of their reserves. When the central bank injects money into the economy, banks can use that money to make loans. The borrowers then deposit the loans into their bank accounts, which the banks can then lend out again. This process can continue until the entire amount of new money has been lent out.

Money Supply Targeting

Money supply targeting is a Monetary Policy strategy in which the central bank sets a target for the growth rate of the money supply. The central bank then uses open market operations to achieve that target.

Money supply targeting is used to control inflation. When the central bank believes that inflation is too high, it will raise interest rates and sell government bonds. This will reduce the money supply and help to bring down inflation.

When the central bank believes that inflation is too low, it will lower interest rates and buy government bonds. This will increase the money supply and help to raise inflation.

Money supply targeting is a controversial monetary policy strategy. Some economists believe that it is an effective way to control inflation. Others believe that it is too rigid and that it can lead to economic instability.
Demand for money

• What is the demand for money?
  The demand for money is the amount of money that people and businesses want to hold at a given time.

• What are the factors that determine the demand for money?
  The demand for money is determined by the following factors:

  • The interest rate: A higher interest rate means that people can earn more by saving their money, so they will demand less money for transactions and precautionary purposes.
  • The expected inflation rate: If people expect inflation to be high, they will demand more money to hold on to as a store of value.
  • Real income: If people’s real income (income adjusted for inflation) increases, they will demand more money to spend on goods and services.
  • Liquidity preference: People’s preferences for liquidity (holding cash rather than other assets) will also affect the demand for money.

• What are the different Types of money demand?
  There are three main types of money demand:

  • Transactions demand: This is the demand for money to hold for everyday transactions.
  • Precautionary demand: This is the demand for money to hold as a buffer against unexpected expenses.
  • Speculative demand: This is the demand for money to hold as a store of value when people expect the value of other assets to fall.

Supply of money

• What is the supply of money?
  The supply of money is the total amount of money in circulation in an economy.

• What are the factors that determine the supply of money?
  The supply of money is determined by the following factors:

  • The monetary policy of the central bank: The central bank can increase or decrease the supply of money by buying or selling government bonds.
  • The public’s demand for money: If the public wants to hold more money, the supply of money will increase.
  • The amount of money that banks create: Banks can create money by lending out money that they have deposited.

• What are the different types of money supply?
  There are two main types of money supply:

  • M1: This is the narrowest measure of money supply and includes currency in circulation and demand deposits.
  • M2: This is a broader measure of money supply and includes M1 plus Savings deposits, small time deposits, and Money Market Mutual Funds.

Money multiplier

• What is the money multiplier?
  The money multiplier is the ratio of the change in the money supply to the change in the monetary base.

• How does the money multiplier work?
  The money multiplier works because when the central bank buys government bonds, it injects money into the economy. This money is then deposited in banks, which can then lend out a multiple of this amount. This process of money creation continues until the entire amount of money that the central bank injected into the economy has been lent out.

• What are the factors that affect the money multiplier?
  The money multiplier is affected by the following factors:

  • The reserve requirement: The reserve requirement is the percentage of deposits that banks are required to hold in reserve. A higher reserve requirement will reduce the money multiplier.
  • The desired reserve ratio: The desired reserve ratio is the percentage of deposits that banks choose to hold in reserve. A higher desired reserve ratio will reduce the money multiplier.
  • The public’s demand for money: If the public wants to hold more money, the money multiplier will decrease.

Money supply targeting

• What is money supply targeting?
  Money supply targeting is a monetary policy strategy in which the central bank sets a target for the growth rate of the money supply.

• Why do central banks use money supply targeting?
  Central banks use money supply targeting to control inflation. By setting a target for the growth rate of the money supply, the central bank can try to keep inflation in check.

• What are the advantages and disadvantages of money supply targeting?
  The advantages of money supply targeting are that it is a simple and transparent policy, and it can help to control inflation. The disadvantages of money supply targeting are that it is difficult to control the money supply accurately, and it can lead to fluctuations in economic activity.

• The demand for money is a function of:

  • The interest rate
  • The expected inflation rate
  • The level of real income
  • All of the above

• The money multiplier is the ratio of the money supply to the monetary base. It is equal to:

  • 1 + the reserve requirement
  • 1 / the reserve requirement
  • 1 + the currency-to-deposit ratio
  • 1 / the currency-to-deposit ratio

• Money supply targeting is a monetary policy strategy in which the central bank sets a target for the money supply and then uses open market operations to achieve that target.

• The transactions demand for money is the demand for money to hold for day-to-day transactions. It is positively related to the level of real income.

• The precautionary demand for money is the demand for money to hold as a buffer against unexpected expenses. It is positively related to the level of uncertainty in the economy.

• The speculative demand for money is the demand for money to hold as an asset that is expected to appreciate in value. It is negatively related to the interest rate.

• Central bank money is the money that is created by the central bank. It includes currency in circulation and reserves held by Commercial Banks.

• Commercial bank money is the money that is created by commercial banks. It includes demand deposits and other types of checking accounts.

• An increase in the money supply will cause:

  • Interest rates to fall
  • Prices to rise
  • Real GDP to rise
  • All of the above

• A decrease in the money supply will cause:

  • Interest rates to rise
  • Prices to fall
  • Real GDP to fall
  • All of the above