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Economics 201 Data Exercise Essay

COMPONENTS OF MONEY SUPPLY CORINE E. PABON ECON201 March 5, 2013 What is the meaning of money supply? To half of the human population money supply is government assistance i. e. unemployment checks, disability checks, food stamps, etc. Some people feel it is utilize to pay for wars and mass destructions. To others it’s just translated into their household and how the next bill is going to be paid. On a contrary, although these circumstances play a role, the meaning of money supply is a little more complex. Money supply basically means “money stocked” it is the total amount of monetary assets available in an economy at a specific time.

There are several ways to define “money,” but standard measures usually include currency in circulation and demand deposits. These currencies are held by the public or in accounts in banks. There are many components of money supply, but the primary components are M0, M1 and M2. These primary components are considered to be the base of the money supply. Some other components that take an account are M3 or M4 for the economies with less liquid assets. Below shows a chart of M1, M2, M3 The graph above shows year-to-year growth as a measure of the changing money supply.

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The numbers at the bottom of graph represent the years and the numbers left shows annual change. According to John Williams “a downward slope in this growth curve does not necessarily mean that the money supply is dropping. Only if the curve goes below zero does that show money supply having contracted over a full twelve months”. Let’s get into detail about the primary components of money supply. M0 represents central bank’s monetary liabilities; this is generally referred to as the reserve money. Here is a chart of the M0 money supply as recently reported: As you can see, the amount of capital held on hand in the US central bank ell from more than $2. 7 trillion in the summer of 2011 to less than $2. 6 billion today. While that seems like a small move, such changes in the amount of cash on reserve are actually quite large. M1 represents the currency in circulation plus demand deposits or checking account balances. Notice how the two metrics tend to move in opposite direction, with time deposits declining and more liquid cash rising after the early 1990s recession as well as after the 2000 recession. M2 includes all of M1 plus savings and time deposits held at banks. As you can see growth is dropping sharply and approaching zero.

This helps explain the current jitters in the market and the increasing talk about recession or depression. In order to understand money supply, one must understand the process of the banking sector. When one makes a deposit, the bank does not keep all of these deposits on hand because they know that depositors will not demand all of these deposits at once. Banks keep only a fraction of the deposits that they receive. The deposits that banks keep on hand are known as the banks’ reserves. When depositors withdraw deposits, they are paid out of the banks’ reserves.

The reserve requirement is the fraction of deposits set aside for withdrawal purposes. Below is a table that shows an example of how banks create money: TABLE 1 | The Balance Sheet of A Typical Bank | Assets | Liabilities | Reserves| $100,000| Deposits| $1,000,000| Loans| 900,000| | | Note: This shows an example of if a bank sets 10% of the deposit into the reserves The assets are valuables that consist of the bank’s reserves and loans (bank owned). The liabilities are valuables that the bank owes to others (depositors money). When a fraction of the money is set in the reserves the banks utilize this as loans with interest.

Remember, a bank’s assets must always equal its liabilities. This is most likely the reason why the first steps into applying for a loan are credit checks. A bank has a lot at stake; if the bank hands out a loan to someone who does not have good credit history it’s a big possibility they would lose out on a lot of valuables. In conclusion with the information provided one can make an analysis that the amount of money in a nation’s money supply is crucial to the health of its economy. If there is not enough money in circulation, the economy cannot grow.

However, too much money in circulation can also cause serious problems. If we all have too much money, and loans are too easy to obtain, the money itself loses value and inflation results. References (2013). The Components of the Money Supply . [ONLINE] Available at: http://www. transtutors. com/homework-help/macro-economics/money-banking/money-supply-components/. [Last Accessed 06 March 13]. John Williams (e. g. 2011). Analysis Behind and Beyond Government Economic Reporting. [ONLINE] Available at: http://www. shadowstats. com/charts/monetary-base-money-supply. [Last Accessed 04 March 13].

Bob Demarco (2010). M2, Money Supply a Sobering View (Graph) — A Look Beyond the Obvious . [ONLINE] Available at: http://allamericaninvestor. blogspot. com/2010/06/m2-money-supply-sobering-view-graph. html. [Last Accessed 07 March 13]. Mike Hewitt (2009). Monetary Policy and the U. S. Dollar. [ONLINE] Available at: http://dollardaze. org/blog/? post_id=00578. [Last Accessed 07 March 13]. Seeking to build the world’s most accurate stock market timing model. [ONLINE] Available at: http://www. crystalbull. com/stock-market-timing/Money-Supply-chart/. [Last Accessed 07 March 13].

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