22) money supply Flashcards
what is money supply?
The money supply measures the total amount of money in the economy at a particular time. It includes actual notes and coins and also any deposits which can be quickly converted into cash. Assets that are easily converted into cash are Liquid Assets. Examples of liquid assets include bank current accounts, saving accounts, money market accounts. An asset is liquid if you can quickly turn it into spendable cash without a significant penalty or loss in the underlying value.
A good example of an asset that is not liquid is property
what is narrow money?
Narrow Money: (M0) -This is the level of notes and coins in circulation + banks operational balances at the Bank of England. (these are overnight balances that banks hold in an account at the central bank-they are used for settling payments between the banks)
what is broad money?
Broad money e.g. M4 money supply is defined as a measure of notes and coins in circulation (MO) + bank accounts.
It is a broader definition because it includes bank accounts, and not just notes and coins in circulation.M4 also includes near money; i.e. non-cash assets which can be changed into cash within a relatively short period.
For example, broad money can also include Treasury Bills and gilts.
These financial securities are seen as ‘near money’ because they are more illiquid than cash and instant saving accounts.
why is broad money significant?
M4 is a key statistic because it can illustrate the underlying strength of economic activity. When the economy went into recession, we see a sharp fall in M4 growth from 15% a year to negative growth in mid-2008.
what relationships is there between money supply and price level?
This relationship is a positive one, i.e. increases in the money supply increase price level and decreases in the money supply should lower PL. This relationship is explained by the Fisher Equation of Exchange, which lies at the heart of the Quantity Theory of Money.
what is he fisher equation?
MV=PT
M= money supply
V= Velocity of Circulation
P= Price Level
T= Transactions (sometimes referred to as Q (quantity of goods sold) or Y (national output)
what is MV?
MV= the amount of goods + services bought in the economy,
what is PT?
PT (PQ) is the amount of goods sold the economy. As what is bought = what is sold, MV must =PT.
why is the Fisher equation important? + arguement
The importance of this equation is its use as an explanation for inflation. Some economists (called monetarists) argue passionately that V and Q are relatively fixed and will certainly even out over time. Their conclusion therefore is that the only way that P/PL can increase is due to increased M, i.e. higher money supply. This leads monetarists to argue that inflation, always and everywhere is a monetary phenomenon, i.e. caused by increased money supply. To solve inflation, you need to reduce money supply. Needless to say, Keynesians completely disagree (more later on that).
What is the summary of the Monetarist’s arguement?
money. Monetarist are adamant that increases in the money supply are the only true cause of inflation and the use they use the Fisher equation of Exchange to illustrate that, holding V and Q(T, Y) fixed.
