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Module 2 Assignment - FORIO

The money supply in an economy is determined by both exogenous and endogenous factors. Exogenously, the central bank influences money supply through tools like required reserve ratios and controlling bank reserves. Endogenously, money supply is affected by the public's preferences to hold currency versus bank deposits and economic activity levels. No countries today use gold or silver as the standard currency because it is impractical, as commodity-backed currencies are subject to hoarding and the value of precious metals fluctuates significantly.

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Lhyn Forio
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46 views

Module 2 Assignment - FORIO

The money supply in an economy is determined by both exogenous and endogenous factors. Exogenously, the central bank influences money supply through tools like required reserve ratios and controlling bank reserves. Endogenously, money supply is affected by the public's preferences to hold currency versus bank deposits and economic activity levels. No countries today use gold or silver as the standard currency because it is impractical, as commodity-backed currencies are subject to hoarding and the value of precious metals fluctuates significantly.

Uploaded by

Lhyn Forio
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© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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MONETARY POLICY

Forio, Ginalyn F.

MODULE 2 ASSIGNMENT
Answer the following:

1. Discuss the mechanism that determines the level of money supply in an economy.

ANSWER:

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

M1, for example, is also called narrow money and includes coins and notes that are in circulation and other

money equivalents that can be converted easily to cash. 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. 3 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. 4

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 Feb. 11, 2021, a little over $18.1 trillion

in M1 money was in circulation, and about $19.4 trillion in M2 money was circulating in the United States.5
Determinants of Money Supply:

There are two theories of the determination of the money supply. According to the first view, the money

supply is determined exogenously by the central bank. The second view holds that the money supply is

determined endogenously by changes in the economic activity which affects people’s desire to hold

currency relative to deposits, the rate of interest, etc.

Thus the determinants of money supply are both exogenous and endogenous which can be described

broadly as: the minimum cash reserve ratio, the level of bank reserves, and the desire of the people to hold

currency relative to deposits. The last two determinants together are called the monetary base or the high

powered money.

1. The Required Reserve Ratio:

The required reserve ratio (or the minimum cash reserve ratio or the reserve deposit ratio) is an important

determinant of the money supply. An increase in the required reserve ratio reduces the supply of money

with commercial banks and a decrease in required reserve ratio increases the money supply.

2. The Level of Bank Reserves:

The level of bank reserves is another determinant of the money supply. Commercial bank reserves consist

of reserves on deposits with the central bank and currency in their tills or vaults. It is the central bank of

the country that influences the reserves of commercial banks in order to determine the supply of money.

The central bank requires all commercial banks to hold reserves equal to a fixed percentage of both time

and demand deposits. These are legal minimum or required reserves.

3. Public’s Desire to Hold Currency and Deposits:

People’s desire to hold currency (or cash) relative to deposits in commercial banks also determines the

money supply. If people are in the habit of keeping less in cash and more in deposits with the commercial

banks, the money supply will be large. This is because banks can create more money with larger deposits.
On the contrary, if people do not have banking habits and prefers to keep their money holdings in cash,

credit creation by banks will be less and the money supply will be at a low level.

4. Other Factors:

The money supply is a function not only of the high-powered money determined by the monetary

authorities, but of interest rates, income and other factors. The latter factors change the proportion of

money balances that the public holds as cash. Changes in business activity can change the behaviour of

banks and the public and thus affect the money supply. Hence the money supply is not only an exogenous

controllable item but also an endogenously determined item.

2. No country anywhere in the world today has an enforceable gold standard or silver standard currency
system. Why? Discuss

ANSWER:

Right now, gold and silver coin are minted by many governments in specific weights. Those circulate and

can be used as currency anywhere they are accepted as currency, just like Bitcoin and the other “crypto”

currencies. After all, the definition of a currency is only that it is generally accepted, not that it be anything

else. The global economy has come a long way since it started using cowrie shells as currency. We have

moved away from commodity and commodity-backed paper money to fiat currency.

Nowhere are gold and silver used as regular currency these days. The United States stopped using gold as

regular circulation currency in 1934, and stopped using silver as such in 1964. In most countries, it had

probably already been given up by then. Some countries had diluted their silver currency down to 40% or

50% before they dropped it altogether.

But if anyone tried to issue gold or silver currency for actual usage today, it'd be totally impractical. A silver

ounce would have to go for $20, and a gold ounce would go for well over $1000. Furthermore, in times of

uncertainty people would naturally tend to hoard the precious metal.

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