Increasing Money Supply

Readers Question: I’d like to ask you about routine ways (apart from so called “printing new money”) by which the total volume of money in economy grows.

Governments or central banks “print new money” apparently only rarely, but given the fact of almost persistent inflation throughout decades, the total volume of money in the economy must grow persistently and significantly anyway.

If a central bank lends money, does it (in normal circumstances) always only turn the central bank’s cash into central bank’s (loan) debtors? Is it really absolutely unusual that by giving a new loan a central bank at the same time also increases its assets and capital (i.e. makes a capital injection into its cash, increasing that way its cash rather than using only its old cash to give a new loan)?

Also, when we are talking about “printing new money”, does it only mean issuing new money for the government expenses rather than only for the central bank’s loans, new money being issued in that or other way anyway?

The money supply measures the stock of money in the economy.

• A narrow definition of money (M0) includes the stock of notes / coins and operational deposits at Bank of England
• A broad definition of money (M4) is notes and coins + deposits in bank accounts+ other liquid assets.

Ways to increase the money supply

1. Print more notes – usually by Central Banks
2. Central Bank can electronically create money. They can change their bank reserves. This is done under the policy of quantitative easing.
3. Increase lending of money by Banks – If banks hold a small % of bank deposits as cash, they can lend out more cash and this increases the money Supply
4. Central Bank buying government securities. i.e. Central Bank pay people in return for bonds. If the Central Bank buy Government securities (or corporate bonds) People who were holding the bonds have more money to spend. Banks see illiquid assets become liquid. Therefore, in certain circumstances this can lead to an increase in the money supply. However, it depends on whether the bond purchases are sterilised or ‘unsterilised’. Unsterilised means they create money to buy bonds.

In recent decades the money supply has been increasing because:

• Reduction in reserve ratio by banks
• Creation of new types of liquid assets which
• Increased velocity of circulation. – The number of times cash changes hands.

Link Between Money Supply and Inflation MV=PY

In theory an increase in the Money supply causes inflation (if money supply increases faster than real GDP)

However, in practise the link between money supply and inflation is weak.

One reason is that the velocity of circulation (number of times cash changes hands) is volatile – it tends to follow the business cycle. For example, in 2008, a recession in the US caused the velocity of circulation to fall and therefore money supply grew slower despite increases in the monetary base.

• Link between Money Supply and inflation
• Money Supply and inflation in US
• Questions on Money Supply