Money supply

Money supply is the amount of money available in the economy in a given period of time. It includes the currency in circulation in the economy, and demand deposits in banks. Economic analysts are interested in monitoring changes in the money supply, due to its impact on the price level, economic inflation, the exchange rate, and the economic cycle. There is a strong relationship between money supply growth and price inflation. In countries that are witnessing a rapid increase in their money supply, they are also witnessing a rapid rise in prices. For this reason, central banks use monetary policy to control inflation by regulating the money supply.

Economists divide the money supply into two parts:

• Narrow money supply (M1): It includes the currency in circulation in the economy, and demand deposits in banks.
• Broad money supply (M2): In addition to the above, it includes time deposits, savings deposits, foreign currency deposits, and various funds in the money markets.

Monetary authority and its tools:

It is the authority responsible for managing monetary policy in the country. The objectives of monetary policy are to stabilize prices, support economic growth, and achieve monetary stability.

The monetary authority uses a set of tools to influence the money supply. These tools differ from one country to another, but they share their main goal, which is to control the size of the money supply to achieve the state’s economic goals.

Traditional tools

• Discount rate: It is the interest rate charged by the central bank on the loans it provides to commercial banks.
• Open market operations: These are the operations of buying or selling treasury bills or bonds by the central bank.
• Legal reserve: It is the percentage that commercial banks must keep of their customers’ deposits with the central bank.

Unconventional tools

A group of unconventional monetary policy tools have emerged in recent years, in light of the global financial crisis in 2008. These tools are as follows:

• Repurchase operations: These are operations by which the central bank purchases treasury bills or bonds from commercial banks at a specific interest rate, and then resells them to them at a later time at a higher interest rate.
• Long-term loans to commercial banks: These are loans provided by the monetary authority to commercial banks at low interest rates.
• Purchasing non-traditional assets: This is when the central bank purchases non-traditional financial assets, such as company shares or mortgage-backed bonds.

Measuring the money supply

Economists use a set of indicators to measure the money supply, and these indicators vary depending on the definition of the money supply.

Indicators related to money supply-to-GDP ratios:

• Money supply-to-domestic product ratio: It is the ratio between the total money supply and the gross domestic product.
• Ratio of paper money in circulation to GDP: It is the ratio between paper money in circulation and GDP.

These indicators indicate the importance of the money supply in the economy, and the extent of its impact on economic activity. The higher the ratio of money supply to GDP, the greater the liquidity in the economy, which may lead to increased economic activity and consumption.

Indicators related to money supply growth rates

• Money supply growth rate: It is the ratio between the change in the total money supply during a certain period of time to the total money supply at the beginning of the time period.
• Growth rate of paper money in circulation: It is the ratio between the change in paper money in circulation during a certain period of time to the paper money in circulation at the beginning of the time period.

These indicators indicate the speed of growth of the money supply and the extent of its impact on prices. The greater the growth rate of the money supply, the greater the potential for prices to rise.

Indicators related to comparing money supply growth rates with price growth rates

Ratio of money supply growth to price growth: It is the ratio between the money supply growth rate and the price growth rate.

These indicators indicate the relationship between money supply and prices. The greater the ratio of money supply growth to price growth, the greater the potential for price increases.

Indicators related to the components of the money supply:

• Ratio of paper money in circulation to the total money supply: It is the ratio between paper money in circulation and the total money supply.
• Ratio of demand deposits to the total money supply: It is the ratio between demand deposits and the total money supply.

These indicators indicate the extent to which paper money in circulation and demand deposits contribute to the total money supply. The greater the ratio of paper money in circulation to the total money supply, the more primitive is circulation in the economy.

These measures aim to analyze and know the mutual effects between the money supply, productivity and consumption indicators, usage indicators, and other prices, with the aim of investigating the policy that is most consistent with general economic objectives.