FACTORS THAT AFFECT MONEY SUPPLY IN AN ECONOMY

12 FACTORS THAT AFFECT MONEY SUPPLY IN AN ECONOMY

  • Level of economic activity. The higher the level of economic activity, the higher the money supply because people get loans from banks to finance these activities and the lower the level of economic activity, the lower the need for loans hence low money supply.




  • The nature of monetary policy. A tight/ restrictive/ contractionary monetary policy leads to low money supply in an economy while an expansionary monetary policy leads to high money supply in an economy.
  • The level of monetization of the economy. An economy with a large monetary sector has got high money supply. However, an economy with a large subsistence sector where money is not used as a medium of exchange has got low money supply.
  • The rate of government borrowing (financial accommodation). A high rate of government borrowing from the central bank implies printing more money which leads to high money supply. On the other hand, a low rate of government borrowing leads to low money supply as less money needs to be printed.
  • Balance of payments position. A balance of payments surplus leads to high money supply because foreign exchange earnings are converted into low currency. On the other hand, a balance of payments deficit leads to low money supply because local currency is used to close the deficit.
  • The level of capital inflow and outflow. Capital inflows say in form of foreign investments by foreigners lead to high money supply while capital outflows like profit repatriation lead to low money supply.




  • The level of credit creation by commercial banks. The higher the level of credit creation by commercial banks, the higher the money supply and the lower the level of credit creation by commercial banks, the lower the money supply. Credit creation leads to high money supply through the multiplier process.

Method of deficit financing. Printing of more money by the government through the central bank to meet budgetary deficits leads to high money supply and government borrowing from the public to finance budgetary deficits leads to low money supply

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