Supply and Demand for Money

Money supply or money stock, is the total amount of money available in an economy at a particular point in time. Changes in money supply affect the price level, inflation and the business cycle.

Money supplycomes in many forms, including currency, demand deposits, time deposits, and plastic money. The narrowest commonly used measure of money M1 consists of currency (bills, coins, money orders and traveler’s checks) and current accounts or checking accounts. Money measure M2 is sometimes called broad money because it includes various not-quite-money monies such as savings accounts. М2 can be presented as M1 + savings accounts + money market accounts. M3 equals to M2 plus large time deposits of $100 000 or more. Narrow money refers to forms of money that are available immediately for use in transactions, broad those that are not immediately available.

When the money supply increases, people have more money to spend, and demand for goods and services increases. This is an economic growth scenario. But, if output does not keep pace with demand, prices increase. When prices rise continuously, inflation results. The central bank is responsible for regulating money supply in the economy.

The demand for money is the desired holding of money balances in the form of cash or bank deposits.Why do people hold (demand) currency and checkable deposits (M1), rather than putting their money to work in stocks, bonds, real estate, or other non-money forms of wealth? John Maynard Keynes, in his 1936 work entitled The General Theory of Employment, Interest, and Money, gave three important motives for doing so: transactions demand, precautionary demand, and speculative demand.

The transactions demand for money is the stock of money people hold to pay everyday predictable expenses. The desire to have ‘walking around money’ to make quick and easy purchases is the principal reason for holding money. Without enough cash, the public must suffer forgone interest.

People have a second motive to hold money, called the precautionary demand for money. The precautionary demand for money is the stock of money held to pay unpredictable expenses. This is the ‘mattress money’ people hold to guard against those proverbial rainy days.

The third motive for holding money is the speculative demand. The speculative demand for money is the stock of money held to take advantage of expected future changes in the price of bonds, stocks, or other non-money financial assets. It is the so called ‘betting money’. As the interest rate falls, the opportunity cost of holding money falls, and people increase their speculative balances.

Demand for money is a crucial implication for the optimal way in which a central bank should carry out monetary policy.

Ex. 1. Match the Russian word combinations with their English equivalents.

Ex. 2. Match the kind of demand for money in A with the stock of money people hold B and the definitions that follow.

1. The stock of money people hold to pay unpredictable expenses.

2. The stock of money people hold to take advantage of expected future changes in the price of bonds, stocks, or other non-money financial assets.

3. The stock of money people hold to pay everyday predictable expenses.

Ex. 3. Discuss the following questions with your partner.

1. How is money supply defined in the text?

2. What are most commonly used measures of money?

3. Who is responsible for regulating money supply in the economy?

4. What is the demand for money?

5. What are the basic types of demand for money?

6. What’s the main reason for having ‘walking around money’?

7. What are the consequences of lacking cash?

8. What do precautionary balances help to avoid?

9. What is the speculative demand for money held for?

10. What happens to the opportunity cost of holding money when the interest rate falls?

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