Tiêu đề Unit -3 Supply of and demand of money .docx ✅

1 Unit -3Supply of and demand for Money Supply ofMoney 1) Explain the base money multiplier theory of money supply. 2) Explain the concept on money supply function. 3) The supply of money is determined by exogenously as well as endogenously factors. Explain in detail. 4) Discuss the base money multiplier theory of money supply determination. 5) What is the determinant of high-power money? 6) How is money supply determined? Explain. 7) The stock of money is the product of high-power money and the money multiplier. Discuss in detail. 8) Explain the concepts of base theory of money multiplier. 9) Discuss the base money multiplier theory of money supply changes. Meaning of money supply Money Supply is an exogenously determined variable. The determinant of money supply is based on some theoretical approach. Therefore, money supply is the total nominal amount of those things that are generally accepted by the public in the form of payment for goods and services and other valuable assets for the discharge of debt. Given, this definition, money is taken in a very narrow sense for theoretical purpose. Thus, base money implies the currency held by the public which is issued by central monetary authority and demand deposit issued by commercial bank. I.e. M = C + DD Where, DD = demand deposit. Thus, there are two features in the narrow money definition i.e. i) It is a generally acceptable medium of exchange. ii) It bears interest. The broader definition of money includes narrow definition plus (+) time depositwhich carry interest rate with them i.e. M2 = C + DD + TD = M1 + TD Thus, money supply both a stock and flow concept. The stock of money supply refers to the amount of money supply at any given point of time. While the flow of money supply refers to the supply of money over a period of time. Based on various determinants and monetary survey carried out by central monetary authority. The central bank decides the money supply. Thus, it is also considered as policy variable that help to implements of monetary policy. In order to study determinants of money supply and process money supply. We study following points: i) High power money (H-Theory) or Base money Theory of money supply. ii) The money multiplier (m)
2 I) H- Theory or Base money theory of money supply. In narrow definition of money, the money supply equation can be written as: M = C + DD …………………… (1)Where, M = Money supply (narrow definition) C = Currency held public issued by central monetary authority.DD = Demand deposits issued by commercial banks The money supply is the liability of the banking system as a whole. In order, for commercial bank to create credit facility in an economy. Central bank requires to put a certain % (i.e. approximately 15% in Nepal) of their totaldeposits as a reserve. This is called the required reserve (RR) Similarly, in order to maintain the required reserve commercial banks voluntarily keeps excess reserve (ER). This is done to meet the liquidity crunch in daily transaction. Thus, the total reserve of commercial bank can be written as: R = RR + ER …………………. (ii) Where R = Total reserve kept by commercial banks RR = Required reserve ER = Excess reserve High power money is the money on the basis of which central bank can create more money supply in the economy. Therefore, the major components of high-power money are as follows: i) Reserve of the commercial bank On the basis of reserve, of commercial bank create credit which increase the money supply. ii) Currency held by public It depends on the public behaviors. This currency can enter the banking system at any time and therefore increase the deposits of bank. Which allows for more credit creation, which ultimately implies increase in money supply. Therefore, high power money equation can be written as: H = C + R ………………………. (iii) Where, H = High power money or base money C = Currency held by public R = Total reserve of commercial bank. Now, from equation (ii) and (iii) H can be changed as, H= C+RR+ER …………………… (iv) In order to calculate money multiplier, we have to find M/H ratio so, M/H= C+DD/C+RR+ER = C/DD+DD/DD//C/DD+RR/DD+ER/DD…………..(V)
3 The division by DD has been carryout as in terms of narrow money definition. DD is the only form of deposit and all the others variables are determined on the basis of deposit. = ………………………. (vi) [m = money multiplier, M = money supply, H = high power money] Thus, we have equation (vi) giving us the money multiplier of narrow definition of money. (Money supply) = × H M/H = m  M = m × H Thus, the total money supply in the economy is given by money multiplier (m) times high power money (H) i.e. MS(M) = m × H Similarly, Money multiplier(m) = M/H Again, high power money (H) = Thus, the money multiplier is a ratio that tells us to what extent high power of money should be increased or decreased to bring about an increase or decrease in money supply. So, far we have seen that there are two major determinants of money supply in an economy i.e. the money multiplier(m) and the high-power money(H). Analyzing this further we know the determinants of money multiplier as three ratiosi.e. C*, rr* and er*. However, we have left high power money at its definition i.e. H= C + R But practically currency held by public cannot be exactly determine and the determination of reserve(R) also depends upon the behavior of commercial bank. Therefore, we now take a look at the balance sheet of central bank to determine source (income) and uses (expenditure) of high-power money. There by its practical determinants. In the Balance sheet of Central Bank Assets = liabilities Liabilities = Monetary liabilities + Non-monetary liabilities Non-Monetary liabilities = Capital + Reserve Assets = Sources (NFER + CCB + NCG + CGE + CPs) Where, NFER = Net foreign exchange reserve
4 CCB = Credit to commercial bank NCG = Net credit to government. CGE = Credit to government enterprises CPs = Credit to private sectors The sources can be explained as below: 1) NFER This implies how much foreign currency that the central bank holds. This depends upon the BOP situation of the economy. 2) CCB The central bank provides the commercial banks both short term and long-term credit. This credit is provided to supplement of the liquidity position of the commercial bank. Therefore, central bank also acts as a lender of last resort to rescue the commercial banks in time of liquidity crisis. 3) NCG Central bank is also the government banks. Therefore, it provides credit to government as and when required. 4) CGE Central bank provides credit to corporation or enterprises run by the government. 5) CPs In some cases, where the sectors fall in the priority and sensitive list then central bank provides credit to private sector. Thus, these are the sources (assets) and the major determinants of high-power money in case of balance sheet calculation of central bank. The uses (liabilities) can be explain as below: Uses = Cp+ R com + R PS Where, Cp = Currency held by the public Rcom = Reserve kept by the commercial bank at Central Bank. R PS = Reserve kept by the private sector at central bank. While analyzing the determinants of high-power money, NFER and NCG are induce source because it depends on the BOP situation. And central bank no control over it. But NCG in a country like Nepal central bank is not completely autonomous. Therefore, cannot set limit to government borrowing. Similarly, the CCB, CGE and CPS are autonomous source because in all these sources central bank has certain control over the money supply. The Central Bank's policy on money supply is also largely guided by