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The term "money supply" commonly denotes the total, safe, financial assets that households and businesses can use to make payments or to hold as short-term investment. [11] The money supply is measured using the so-called "monetary aggregates", defined based on their respective level of liquidity. In the United States, for example:
Central banks may also affect the money supply more directly by engaging in various open market operations. [21] They can increase the money supply by purchasing government securities, such as government bonds or treasury bills. This increases the liquidity in the banking system by converting the illiquid securities of commercial banks into ...
The central bank can directly purchase Government debt that would otherwise have been offered to public sector investors in the financial markets, or the government can simply be allowed to have a negative treasury balance. In either case, new money is created and government debt to private parties does not increase. [2]
However, because the depositor can ask for the money back, banks have to maintain minimum reserves to service customer needs. If the reserve requirement is 10% then, in the earlier example, the bank can lend $90 and thus the money supply increases by only $90. The reserve requirement therefore acts as a limit on this multiplier effect.
The acceptance and value of commercial bank money is based on the fact that it can be exchanged freely at a commercial bank for central bank money. [20] [21] The actual increase in the money supply through this process may be lower, as (at each step) banks may choose to hold reserves in excess of the statutory minimum, borrowers may let some ...
An easy money policy is a monetary policy that increases the money supply usually by lowering interest rates. [1] It occurs when a country's central bank decides to allow new cash flows into the banking system. Since interest rates are lower, it is easier for banks and lenders to loan money, thus likely leading to increased economic growth. [2]
The period when major central banks focused on targeting the growth of money supply, reflecting monetarist theory, lasted only for a few years, in the US from 1979 to 1982. [16] The money supply is useful as a policy target only if the relationship between money and nominal GDP, and therefore inflation, is stable and predictable.
Consequently, the importance of the money supply as a guide for the conduct of monetary policy has diminished over time, [65] and after the 1980s central banks have shifted away from policies that focus on money supply targeting. Today, it is widely considered a weak policy, because it is not stably related to the growth of real output.