Money supply refers to the total amount of money in circulation in an economy at any given time.
TYPES OF MONEY SUPPLY
there are two main types of money supply: exogenous money supply and endogenous money supply.
Exogenous Money Supply: Exogenous money supply refers to the portion of the money supply that is determined and controlled by the central bank. The central bank has the authority to create and inject money into the economy through various mechanisms. The key tools used by the central bank to control the exogenous money supply include:
a. Open Market Operations: The central bank buys or sells government securities (bonds) in the open market. When the central bank purchases these securities, it increases the money supply in circulation, as it pays for the securities by creating new money. Conversely, when the central bank sells securities, it reduces the money supply by withdrawing money from circulation.
b. Reserve Requirements: The central bank establishes reserve requirements, which determine the proportion of deposits that banks must hold as reserves. By adjusting these requirements, the central bank can influence the amount of money that banks can lend out, thereby controlling the overall money supply.
c. Discount Rate: The central bank sets the discount rate, which is the interest rate at which commercial banks can borrow funds directly from the central bank. By raising or lowering the discount rate, the central bank can incentivize or discourage banks from borrowing and, consequently, affect the money supply.
The central bank typically employs these tools to implement its monetary policy objectives, such as controlling inflation, managing economic growth, or stabilizing the financial system. By manipulating the exogenous money supply, the central bank can directly impact the overall liquidity and availability of money in the economy.
Endogenous Money Supply: Endogenous money supply refers to the portion of the money supply that is determined by the economic activity and lending decisions within the banking system. It is influenced by the forces and dynamics existing within the economy. The process of credit creation and the money multiplier effect play a crucial role in the determination of endogenous money supply.
When banks receive deposits, they are required to hold a fraction of those deposits as reserves, as mandated by the reserve requirements set by the central bank. However, banks are allowed to lend out the remainder of the deposits. When a loan is issued, the borrower receives the loan amount as new money, which they can then spend or deposit in another bank. If the funds are deposited in another bank, that bank can lend out a portion of those funds, creating more money in the process. This process continues, leading to the expansion of the money supply.
The endogenous money supply depends on the demand for loans from borrowers and the lending decisions of banks. If there is high demand for credit and economic activity is robust, banks will extend more loans, leading to an increase in the money supply. Conversely, if borrowing decreases or economic activity slows down, the money supply contracts as loan repayments reduce the money in circulation.
It’s important to note that while the central bank’s actions influence the exogenous money supply, the endogenous money supply is determined by the banking system’s lending decisions and the demand for credit from borrowers. The interplay between exogenous and endogenous factors ultimately shapes the overall money supply in an economy.
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