Supply of Money

The supply of money refers to the total amount of money available in an economy at a given point in time. It includes all forms of money, such as cash, demand deposits, and various types of near money. The supply of money is a crucial factor in determining the overall level of economic activity and the stability of prices within an economy.

Suppliers of Money

The suppliers of money can be categorized into two main groups: the central bank and commercial banks.

1. Central Bank:
The central bank, also known as the monetary authority, is responsible for managing the money supply and controlling the stability of the financial system. It acts as the ultimate supplier of money in an economy. The central bank influences the supply of money through various monetary policy tools, including open market operations, reserve requirements, and setting the benchmark interest rate.

- Open Market Operations: The central bank can increase or decrease the money supply by buying or selling government securities in the open market. When the central bank purchases these securities, it injects money into the economy, thereby increasing the money supply. Conversely, when it sells securities, it removes money from circulation, reducing the money supply.

- Reserve Requirements: The central bank also sets reserve requirements for commercial banks, which determine the amount of funds banks must hold as reserves against customer deposits. By adjusting these requirements, the central bank can influence the ability of commercial banks to create new money through lending activities.

- Interest Rate Policy: The central bank sets the benchmark interest rate, which affects the cost of borrowing for commercial banks and the general public. By increasing or decreasing interest rates, the central bank can influence the demand for money, which indirectly affects the money supply.

2. Commercial Banks:
Commercial banks play a significant role in the supply of money by creating new money through the process of fractional reserve banking. When a bank receives deposits from customers, it is required to hold only a fraction of these deposits as reserves, while the remaining amount can be lent out to borrowers. This lending process creates new money in the form of bank deposits.

- Lending Activities: When commercial banks extend loans to borrowers, they simultaneously create new deposit liabilities. These deposits can be used as a medium of exchange, effectively increasing the money supply in the economy.

- Multiplication Effect: The lending activities of commercial banks have a multiplier effect on the money supply. As borrowers spend the newly created deposits, they enter the banking system, allowing banks to make further loans and create more deposits. This process continues, expanding the money supply.

In summary, the supply of money is influenced by the actions of the central bank and commercial banks. The central bank directly controls the money supply through open market operations, reserve requirements, and interest rate policies. Commercial banks contribute to the supply of money through their lending activities and the creation of new deposits.