The discussion about money will never end. What is money supply? From what is the definition, what is the purpose, how to get it easily. However, there may be some money terms that are not really understood by the general public.
Money supply is not common term
Typically, the types of money known to ordinary people are paper money and coins, or also currency and demand deposits. However, there is one type of money whose name is familiar to economists, but still unfamiliar to ordinary people. The term is money supply.
Money supply is key element in macroeconomics
Money supply is the total money supply that is widely circulated in the community. The money supply can include cash, coins and balances held in current and savings accounts, and other money replacements. Economists consider the money supply as a key variable in understanding macroeconomics and guiding macroeconomic policies.
Types of money supply
There are four types of money supply, namely
M0 and M1 are usually referred to as narrow money, which contain money like coins, banknotes and other things equivalent to the money in circulation and can be easily converted into cash.
What is M2?
M2 is a type of money that includes M2, short-term deposits in banks, and certain money market funds.
What is M3?
M3 is money that covers M2 and long-term deposits. To calculate the money supply, the method is to add up all the types of money supply. Data on the money supply can be seen at the central bank.
Money supply affects inflation
Money supply is also one of the instruments that is very tightly regulated by the government. The money supply greatly determines the economic situation of a country. The money supply can affect many components of the economy, including inflation, investment, savings, and the business sector.
For example, if the amount of money circulating in the community is large, then the community will tend to behave in a consumptive manner. When people are consumptive, prices will tend to increase. When that happens, inflation takes place. Consumptive attitude of the community also triggers business people to produce more goods, with the hope that many will be sold. That’s how the money supply affects the running of a country’s economy.
How to regulate money supply?
So, how does the government regulate the money supply in the community? One of the controlling factors for the money supply is by regulating interest rates. When too much money is circulating in the community, this situation will lead to an inflationary situation.
On the other hand, inflation is a bad thing in the country’s economy. To stop it, the government must reduce the money supply by raising interest rates. By raising interest rates, the government hopes that people will flock to save at the bank. This will cause money to be held in the bank so that it will reduce the circulation of money in the community.
Selling securities to regulate money supply
In addition to the interest rate, the government can also regulate the money supply by selling securities. For example, when there is too much money circulating in the community, the government issues securities.
Open market operations to regulate money supply
There is also a way for the government to control the money supply in the community. The method is Open Market Operations. However, some well-known economists such as Robert Lucas, Jr., Thomas Sargent, Neil Wallace, Finn E. Kydland, Edward C. Prescott and Scott Freeman argue that Open Market Operations are irrelevant.
Meanwhile, in relation to the ability of the central bank to predict the amount of money that should be in circulation, economists are also arguing about this. Economists like Milton Friedman believe that the central bank will always be wrong in predicting. This has led to wider economic changes. Because of the debate, economists propose a non-intervention approach to keep the money supply on target.
But as an economics student this term is really needed to give focus. The economic prosperity of a country relies heavily on these concepts. We need to know how can we raise the buying power of a common man in the society. Inflation also has many effects which are not easily bearable by a common citizen.