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.
e.g. M0 = This is the level of notes and coins in circulation + banks operational balances at the Bank of England.
e.g. M4 = This is notes and coins in circulation plus private sector deposits in banks and building societies. Broad money is much larger because it includes all bank accounts. This is denominated in electronic format rather than banks holding notes and coins.
Functions of money
Money must have at least two of these functions
- Medium of exchange
- Store of value
- Deferred payment
- Unit of account
Due to changes in the financial system the money supply has been difficult to measure accurately, this makes it difficult to implement Monetarism, which states there is a relationship between the money supply and inflation.
Money supply and inflation
Monetarists believe there is a strong link between the money supply and inflation. If the money supply increases faster than real output, then prices will increase causing inflation. This is known as the quantity theory of money (MV=PT)
However, other economists believe this link between the money supply and inflation is more complicated.
How to increase the money supply
- Print more money
- Quantitative easing – the electronic creation of money by Central Banks.
- Increased bank lending – banks lending higher % of their deposits.
- Central Bank purchasing bonds from private individuals which can be spent.