Question: 2 explain briefly the money supply process, indicating the

importance of cash ratio. What are the implications for this process of
significant bad debts on loans?
Economists typically defines money as the widely accepted means of payment. Basically money
is anything that could be used to buy goods and services. Now it is clear from this definition that
currency i.e. paper bills and coins, they are definitely money. Most of your payments however
probably made by writing a cheque or using a debit card. Both of this transfer funds from your
bank accounts to seller bank accounts. Making payments through debit card or writing a cheque
is known as checking accounts. Checking accounts are also considered to be as Money. Now for
saving account it is a little bit tricky. Technically you can’t use the funds to buy goods and
services directly. But in practice it is just so easy to move funds from saving accounts to
checking accounts. Therefore we can also define saving accounts to be Money. For same
reasons we often define Money Market Mutual Funds to be money. The basic idea then is this we
count as money “Any asset that is widely used as means of payments for services and goods OR
any asset that can be easily converted into the widely used means of payment with loss in value.
So it is not written on stone that what exactly money is? There could be a Judgement Call. As a
result economists have defines several different measures of the supply of money. This Money
supply process is discussed below.

 What is Money Supply Process?

Money supply is the value of total available money i.e. cash or currency and other liquid
assets that is in circulation in the economy of the country at a certain point of time.
Money supply is also known as money stock. It includes roughly both the deposits that
can be easily used as easy as the cash and the cash itself and it tells us how much physical
currency and assets that can be liquidated easily, are existed in the economy of the
country at a certain particular point of time. This data is usually measured by the central
bank and the way it is measured may vary country to country.
Economists analyze the basic concept of the money supply and thus they develop certain
policies that revolves around it through controlling the inflation and the interest rate and
decreasing or increasing the amount of the money that flows in the economy. Also
private and public sectors are analyzed because money supply possible affect the level of
prices, business cycle and inflation.
In the United States, the Federal Reserve policy is the most important deciding
factor in the money supply. The money supply is also known as the money stock.

Today in most of the countries, central bank and other institutions are charged with
issuance of domestic currency. This charge is considered to be very important because
 the money supply directly influence the inflation and the interest rates and ultimately the
aggregate of the output. If the monetary policy of the central bank is good, if it creates the
right money’s amount, then the economy will hum and then it decreases the inflation and
the interest rate. And if monetary policy creates too quickly too much money, then there
will be the rapid increase in the prices and this will wipe out the savings of the people
until it converts the poorest into the nominal billionaire i.e. Zimbabwe is the example of
such situation. And if it creates money too little and too slowly, then it will wiping out
the debtors and prices will decreases and it became nearly impossible to earn profit from
the business. Therefore in order to avoid such issues, every individual must have to
understand that what is money supply process?
Money supply ultimately is determined by the four groups’ interaction: commercial
banks and other financial depositories, borrowers, depositors and the central bank itself.
Central bank is the part of the government but like every other bank the balance sheet of
the central bank consists of two parts: assets and liabilities. The asset side is same i.e.
consists of government securities. However the liabilities side is different. It consists of
reserves and currency in circulation. Government issues the coins and paper currency
through the combination of treasuries and central bank. Money supply that is available to
the people is influences by the bank regulators via requirements placed on the bank to
hold the reserves. It is the responsibility of the central bank to bring the money into the
banking system. The central bank have a direct control over the monetary base. It is also
known as the high powered money because money stock act as the base with which
bigger stocks of monetary assets are created.
In the US for example, the most popular data points are: Mo
Effect of Money Supply on the Economy
An increase in the supply of money typically lowers interest rates, which in
turn, generates more investment and puts more money in the hands of
consumers, thereby stimulating spending. Businesses respond by ordering more
raw materials and increasing production. The increased business activity raises
the demand for labor. The opposite can occur if the money supply falls or when
its growth rate declines.

Change in the money supply has long been considered to be a key factor in
driving macroeconomic performance and business cycles. Macroeconomic
schools of thought that focus heavily on the role of money supply include Irving
Fisher's Quantity Theory of Money, Monetarism, and Austrian Business Cycle
Theory.

Historically, measuring the money supply has shown that relationships exist
between it and inflation and price levels. However, since 2000, these
relationships have become unstable, reducing their reliability as a guide for
monetary policy. Although money supply measures are still widely used, they are
one of a wide array of economic data that economists and the Federal Reserve
collects and reviews.1

How Money Supply is Measured

The various types of money in the money supply are generally classified as Ms,
such as M0, M1, M2 and M3, according to the type and size of the account in
which the instrument is kept. Not all of the classifications are widely used, and
each country may use different classifications. The money supply reflects the
different types of liquidity each type of money has in the economy. It is broken up
into different categories of liquidity or spendability.2

M0 and M1, for example, are also called narrow money and include coins and
notes that are in circulation and other money equivalents that can be converted
easily to cash.3 4 M2 includes M1 and, in addition, short-term time deposits in
banks and certain money market funds.1 M3 includes M2 in addition to long-term
deposits. However, M3 is no longer included in the reporting by the Federal
Reserve.5 MZM, or money zero maturity, is a measure that includes financial
assets with zero maturity and that are immediately redeemable at par. The
Federal Reserve relies heavily on MZM data because its velocity is a proven
indicator of inflation.6

Money supply data is collected, recorded, and published periodically, typically by

the country's government or central bank. The Federal Reserve in the United
States measures and publishes the total amount of M1 and M2 money supplies
on a weekly and monthly basis. They can be found online and are also published
in newspapers. According to data from the Federal Reserve, as of March 2019 a
little over $3.7 trillion in M1 money was in circulation, while almost $14.5 trillion in
M2 money was circulating in the United States.7

Importance of cash ratio:

Definition of Cash Ratio – The ratio of cash to total liabilities a bank will hold. For example, suppose that
a bank has deposit of £100 billion. If if has a cash ratio of 1%, it will need to hold £1billion on cash
reserves.

A cash ratio determines how much credit can be created from deposits. It also determines the
profitability of a bank. If cash ratios are higher then banks will be less profitable. However, higher cash
ratios do enable greater security.
Definition: Also known as Cash Reserve Ratio, it is the percentage of deposits which commercial banks
are required to keep as cash according to the directions of the central bank.

Description: The reserve ratio is an important tool of the monetary policy of an economy and plays an
essential role in regulating the money supply. When the central bank wants to increase money supply in
the economy, it lowers the reserve ratio. As a result, commercial banks have higher funds to disburse as
loans, thereby increasing the money supply in an economy.

On the other hand, for controlling inflation, the CRR is generally increased, thereby decreasing the
lending power of banks, which in turn reduces the money supply in an economy.
Conclusion:
Money can be