Money Supply Theory
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Money Supply Theory in macroeconomics refers to the study of the quantity of money available at the hands of people within the economy to buy goods, services and securities. The interest rate is the value of money over time, that is the price paid for acceding payment of monetary debts. These two are inversely proportional as the supply of money increases the interest rate decreases. The equilibrium at the money market is reached when the quantity of money demanded and supplied becomes equal to the rate of interest. Money involves both coins and banknotes, therefore the supply of money in an economy will consist of both the supply of banknotes and coins. Precisely the concept of money supply involves the sum total of all electronic, credit-based bank deposits balance accounts along with the printed-paper notes and minted coins. According to the principle, money is a medium of transaction that is utilized in settling a debt. Money supply can take place in varying measures. The narrowest measure counts only liquid money while the broader measure takes into account the form that deals money as a store of value. The situation of inflation occurs when the supply of money increases to an extreme level.
Role of Central Bank in Supply of Money
When the Central Bank is ‘easing’ the money supply increases and when it is ‘tightening’ the money supply decreases. In the condition of easing more liquid money is available for the private banks. During the condition of tightening the liquid money is pulled out of the private banking sector. The Central Bank also creates new reserves that let the banks lend out more money. Then through the process of ‘money multiplier’ the loans and bank reserves increase. According to Mises the state of the art monetary policy of money supply expansion runs the risk of undermining the value of currency. Mises endorsed the view of formulating a monetary policy that is different from the state of the art monetary policy. He aspired to minimize the risk of devaluation and create a free society.
