MONEY SUPPLY

DETERMINANTS OF MONEY SUPPLY
There are two alternate theories in respect of determination of money supply. According to the first view, money supply is determined exogenously by the central bank. The second view holds that the money supply is determined endogenously by changes in the economic activities which affect people’s desire to hold currency relative to deposits, rate of interest, etc. The current practice is to explain the determinants of money supply based on ‘money multiplier approach’ which focuses on the relation between the money stock and money supply in terms of the monetary base or high-powered money. This approach holds that total supply of nominal money in the economy is determined by the joint behaviour of the central bank, the commercial banks and the public. Before we discuss the determinants of money supply, it is necessary that we know the concept of money multiplier.

 THE CONCEPT OF MONEY MULTIPLIER

The money supply is defined as

            M = m X MB

Where M is the money supply, m is money multiplier and MB is the monetary base or high powered money. From the above equation we can derive the money multiplier (m) as

                     Money Multiplier (m)= Money supply/monetary base
Money multiplier m is defined as a ratio that relates the changes in the money supply to a given change in the monetary base. It denotes by how much the money supply will change for a given change in high-powered money. The multiplier indicates what multiple of the monetary base is transformed into money supply.
                If some portion of the increase in high-powered money finds its way into currency, this portion does not undergo multiple deposit expansion. In other words, as a rule, an increase in the monetary base that goes into currency is not multiplied, whereas an increase in monetary base that goes into supporting deposits is multiplied.