Percentage in Point

Components of Money Supply
Tools Which Are Used By The Federal Reserve To Increase The Money Supply
Understanding Money Base And Money Supply

Posted: 19 Aug 2010 09:20 AM PDT

In economics, money supply is defined as the amount of money in the economy, measured according to varying methods or principles. One such method incorporates only money that is usually used to purchase goods and services, such as cash and the contents of checking accounts. There are several measures for the money supply such as M0, M1 and M2.

The First measure, M0, generally comprises of the money in the hand of the general public, the statutory deposits of the banks held by the central bank and its cash reserves. This M0 is often referred to as the monetary base of the economy. The next measure, M1, includes M0 and in addition to it, the foreign currency deposits which are needed in domestic transactions.

Further on, M2 includes both M0 and M1 combined and in addition takes in account the short term savings, deposit certificates, transferable foreign currency deposits and repurchase agreements.

In an economy, these three measures, M0, M1 and M2 are often considered as the primary components of the money supply circulating in the economy. However, apart from these there could be cases where broader measurements maybe required. This might be true when the case deals with less liquid asset and this is where the M3 and M4 components come in.

Tools Which Are Used By The Federal Reserve To Increase The Money Supply

Posted: 19 Aug 2010 09:17 AM PDT

Its important that you control the supply of money which is available in the country. The monetary policy which has been introduced by the US Federal Reserve and the countries central bank requires these important tools to control the supply of money available in the economy. These tolls includes the open market operations, the discount rates, fractional reserves and many more.

Open Market Operation:

The open market operation is one of the best tools to increase money supply. The Federal Reserve uses the open market to buy the treasury securities which belong to the government itself and which in turn can help in increasing the supply of money in small amount or percentage with a period of time. These treasury securities contain a treasury bonds which have a long life till decades. But the treasury notes have a life time of two to ten years. Moreover there are also treasury bills which increase in one year or maybe less than that. But besides all this these are the most favored instruments used by the Federal Reserve.

Discount Rate:

The next tool which the Federal Reserve uses to increase the money supply is the use of discount rate. When the banks have the requirement of day to day money than they borrow it from Federal Reserve and these loans carry such interests which are known as discount rates. The Federal Reserve adjusts the discount rates and while doing this delivers a clear and comprehensive message if the money supply will increase or decrease. The bank borrows the money from the Federal Reserve when the money supply decreases and this borrowed money is then used for the business so that it can expand and also towards the housing loans in order to increase money supply in the economy.

Fractional Reserve:

This is another tool which is used by the Federal Reserve to increase money and that is fractional reserve. This can happen at any time that the all the depository institutes including bank are required to some of the percentage of their check accounts which are interest bearing as well as non interest bearing as a shape of reserve with the Federal Reserve. Which means that the required reserves are actually the fraction of the deposits and the federal reserves uses these changes in the system to improve the impact in the market.

To increase the money supply the Federal Reserve will increase the Fed fund rates so that its easy foe the bank to lend more.

Understanding Money Base And Money Supply

Posted: 18 Aug 2010 09:48 PM PDT

Monetary base is the total amount on which the liquid currencies circulate in the hands of the public. The deposits in the financial institutions and the deposits which are of the commercial bank are in the central bank of the respective country.

If the country has seven million currencies among the public and ten billion in the central bank as commercial bank deposits then the money base of the country will be ten point seven billion currencies. This is the monetary base which is the ultimate source of a country's money supply. Open market operations have direct impact on the money base as they are included in one of the many monetary tools. In order to keep the measure of control on the country’s monetary base government;s bonds are bought and sold in the open markets. This implementation of the open market also uses the method of monetary targets like interest rates or exchange rates. the monetary base can also be expanded using an expansionary policy and can also be contracted by using a concretion policy. Both have risks involved in them and both are controlled by the country’s central bank or the finance ministry.

Money supply is that amount which is available in the economy of the country and is used for the purchases of goods and services and for other investment purposes. Money in the economy can be measured in many ways. It can be measured by parameters or statistical methods.

In the US, the federal reserves and the country’s central bank has been successful in identifying the components of the money supply at M1, M2, M3 and L.

M1 is that currency which is held by the country’s public for the use of various things like travelers check, demand deposits and also many other different types of accounts like NOW accounts, super NOW accounts, credit union drafts and ATS accounts.

Where as the M2 is the currency which is deposited in M1 including the small and savings denomination time deposits. M2 also includes many other fund shares which are invested by many other individual investors who wish to invest their money.

Just like M2 currency includes M1, the same way M3 currency also includes M2 deposits including the large time deposits, investments which are done by the large time deposits and the investment which is done by other institutional investors in the country.

L, which is also one of the components of the money includes all M3 forms of currency deposits, long term liquid assets, non-bank investments and commercial papers along with bankers acceptance.

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