Money Supply. Total amount of money held by nonbank public at a point of time in the economy.

Includes both currency in circulation

and demand deposits.

Narrow money. Type of money more easily affected by monetary policy. Exists in smaller quantities. Broad money. More difficult to do
so. Larger quantities.

M0. Physical currency. Narrow, is smallest measure of money supply. Measure of money supply which combines any liquid or cash
assets held within a central bank and the amount of phys currency circulating in the economy. Most liquid measure of money supply
only includes cash or assets that can quickly be converted to currency.

M1. (M0 + demand deposits, i.e. checking accounts). Used as a measurement for economists trying to quantify amount of money in
circulation. V liquid measure of money supply contains cash & assets that can be quickly converted into money.

M2 (M1 + small time deposits i.e. < $100 000, savings deposits, non-institutional money-market funds). Broader than M1. M2 used to
quantify money in circulation + explain diff economic monetary conditions. Key economic indicator to forecast inflation.

M3 (M2 + all large time deposits, institutional money-market funds, short-term repurchase agreements, & larger liquid assets).
Broadest measure of money used to estimate entire supply of money within an economy.

2 official UK measures. M0 (narrow money) : Cash outside Bank of England + Banks' operational deposits with Bank of England.
M4 (broad money/ money supply) : Cash outside banks (ie. in circulation with the public and non-bank firms) + private-sector retail
bank and building society deposits + Private-sector wholesale bank and building society deposits and Certificate of Deposit

Fractional Reserve Banking

Whenever a bank gives out a loan in a fractional-reserve banking system, a new type of money is created. This new type of money is
what makes up the non-M0 components in the M1-M3 statistics. In short, there are two types of money in a fractional-reserve banking
system

Central bank money (phys currency) = M0

Comm bank money (money created through loans, sometimes known as checkbook money) = M1, 2, 3.
Types of comm bank money that tend to be valued at lower amounts are classified in the narrow category of M1 while the
types of commercial bank money that tend to exist in larger amounts are categorized in M2 and M3, with M3 having the
largest.

Components of Money Market

1. Central bank. Controls issue of money and funds to market + regulates credit facilities provided by other institutions.
2. Commercial banks. Make advances, discount bills, lend against promissionary notes (signed document containing a written
promise to pay a stated sum to a specified person or the bearer at a specified date or on demand). Take help of market in
solving liquidity problems.
3. Discount houses. Special institutions for rediscounting bills of exchange. Deal with domestic, foreign, & gov treasury bills.
Borrow huge funds for short periods from comm banks to invest in discounting bills.
4. Acceptance houses. Specialise in accepting bills of exchange. Merchant bankers. Act as 2nd signatories on bills of exchange =
Guarantee bills of a trader whose financial standing is unknown, to make bill negotiable.
5. Bill brokers. Act as intermediaries between sellers and buyers of bill for a small commission.

Money market = Market for v short period loads. Money at call/ short notice. Rate in market is known as call money rate, determined
by demand and supply of funds. Money lent mainly to bill brokers and stock exchange dealers.

Merits. Money taken back when needed. Earn interest by quick lending of idle cash. Promote stock exchange transitions. Market for
acceptance of trade bills. Main operators in this market: acceptance houses and comm banks. Helps gov by marketing of treasury bills.

Demerits. Promotes operations of discount houses. Makes bills negotiable.

Bill market. Market for short-term bills e.g. buying + selling of short dated papers, bills, etc. Includes comm bill market and treasury bill
market.

Collateral loan market. Takes form of loan overdrafts, cash credits. Loans and advances are covered by collaborates like gov securities,
gold silver, stocks of corporations, merchandise, etc.

Central Banks (Bank of England & European Central Bank)

Assets

1. Gov securities. Securities that are issued by a government to raise the funds necessary to pay for its expenses. These securities can
come in the form of bonds, notes, and other debt instruments.
One of the easiest to understand type of government security is the government bond. Government bonds are simply bonds issued by
a national government that is denominated in the local currency. Government bonds that are issued by a national government can also
be denominated using a foreign currency. These kinds of government bond are called sovereign bonds.

Bonds are issued by governments to investors who then loan the government a specific amount of money. The whole loan principal
and interest is paid back by the government within a specific time frame.

Government bonds and the other types of government securities are usually long-term securities and has the highest market ratings.
The high market ratings make government securities attractive to investors since this means a very low risk investment. With
government securities, you can be sure that you will be paid by the government in full and on time. Due to the risk-free nature of
government bonds, they are usually called risk-free bonds. In case the government is hard up on money by the time the bond or other
government securities need to be paid up, governments usually just simply issue new government securities to obtain new loans or
raise taxes to increase revenue. It is indeed extremely rare for governments to every default on any of its local debts.

2. Loans to monetary financial institutions.

Liabilities

1. Bank reserves (monetary base)

Total amount of a currency that is either circulated in the hands of the public or in the commercial bank deposits held in the
central bank's reserves. This measure of the money supply typically only includes the most liquid currencies; it is also known
as the "money base."

Country Z has 600 million currency units circulating in the public and its central bank has 10 billion currency units in reserve as
part of deposits from many commercial banks. In this case, the monetary base for country Z is 10.6 billion currency units. For
many countries, the government can maintain a measure of control over the monetary base by buying and selling
government bonds in the open market.

The monetary base is a component of a nations money supply. It refers strictly to highly liquid funds including notes, coinage
and current bank deposits. When the Federal Reserve creates new funds to purchase bonds from commercial banks, the
banks see an increase in their holdings, which causes the monetary base to expand.

*MONEY SUPPLY = Entire stock of currency and other liquid instruments circulating in a
country's economy as of a particular time. Also referred to as money stock, money supply
includes safe assets, such as cash, coins, and balances held in checking and savings
accounts that businesses and individuals can use to make payments or hold as short-term
investments.

Economists analyze the money supply and develop policies revolving around it through
controlling interest rates and increasing or decreasing the amount of money flowing in
the economy. Money supply data is collected, recorded and published periodically,
typically by the country's government or central bank. Public and private sector
analysis is performed because of the money supply's possible impacts on price level,
inflation and the business cycle. In the United States, the Federal Reserve policy is
the most important deciding factor in the money supply.

Measuring money supply = 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. 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. M2 includes M1 and, in addition,
short-term time deposits in banks and certain money market funds. M3 includes M2 in
addition to long-term deposits. However, it is no longer included in the reporting by
the Federal Reserve.

The money supply expands beyond the monetary base to include other assets that may be
less liquid in form. It is most commonly divided into levels, listed as M0 through M3 or
M4 depending on the system, with each representing a different facet of a nations
assets. The monetary bases funds are generally held within the lower levels of the
money supply, such as M1 or M2, which encompasses cash in circulation and specific
liquid assets including, but not limited to, savings and checking accounts.

To qualify as part of the money base, the funds must be considered a final settlement of
a transaction. For example, if a person uses cash to pay a debt, that transaction is
final. Additionally, writing a check against money in a checking account, or using a
debit card, can also be considered final since the transaction is backed by actual cash
deposits once they have cleared.

In contrast, the use of credit to pay a debt does not qualify as part of the monetary
base, as this is not the final step to the transaction. This is due to the fact the use
of credit just transfers a debt owed from one party, the person or business receiving
the credit-based payment, and the credit issuer.

At household level, the monetary base consists of all notes and coins in the possession
of the household, as well as any funds in deposit accounts. The money supply of a
household may be extended to include any available credit open on credit cards, unused
portions of lines of credit and other accessible funds that translate into a debt that
must be repaid.

Monetary bases funds are generally held within the lower levels of the money supply, such as M1 or M2, which encompasses cash
in circulation and specific liquid assets including, but not limited to, savings and checking accounts.

To qualify as part of the money base, the funds must be considered a final settlement of a transaction. For example, if a person
uses cash to pay a debt, that transaction is final. Additionally, writing a check against money in a checking account, or using a debit
card, can also be considered final since the transaction is backed by actual cash deposits once they have cleared.

In contrast, the use of credit to pay a debt does not qualify as part of the monetary base, as this is not the final step to the
transaction. This is due to the fact the use of credit just transfers a debt owed from one party, the person or business receiving the
credit-based payment, and the credit issuer.

2. Notes in circulation.

Control of Money by Central Banks

a. Print More Money

As no economy is pegged to a gold standard, central banks can increase the amount of money in circulation by simply printing it.
They can print as much money as they want, though there are consequences for doing so. Merely printing more money doesnt
affect the output or production levels, so the money itself becomes less valuable. Since this can cause inflation, simply printing
more money isn't the first choice of central banks.

b. Set the Reserve Requirement

One of the basic methods used by all central banks to control the quantity of money in an economy is the reserve requirement. As
a rule, central banks mandate depository institutions to keep a certain amount of funds in reserve against the amount of net
transaction accounts. Thus a certain amount is kept in reserve and this does not enter circulation. Say the central bank has set the
reserve requirement at 9 percent. If a commercial bank has total deposits of $100 million, it must then set aside $9 million to
satisfy the reserve requirement. It can put the remaining $91 million into circulation.

When the central bank wants more money circulating into the economy, it can reduce the reserve requirement. This means the
bank can lend out more money. If it wants to reduce the amount of money in the economy, it can increase the reserve
requirement. This means that banks have less money to lend out and will thus be pickier about issuing loans.

c. Influence Interest Rates

In most cases, a central bank cannot directly set interest rates for loans such as mortgages, auto loans, or personal loans.
However, the central bank does have certain tools to push interest rates towards desired levels. For example, the central bank
holds the key to the policy ratethis is the rate at which commercial banks get to borrow from the central bank (in the United
States, this is called the federal discount rate). When banks get to borrow from the central bank at a lower rate, they pass these
savings on by reducing the cost of loans to its customers. Lower interest rates tend to increase borrowing and this means the
quantity of money in circulation increases.

d. Engage in Open Market Operations.

Central banks affect the quantity of money in circulation by buying or selling government securities through the process known as
open market operations (OMO). When a central bank is looking to increase the quantity of money in circulation, it purchases
government securities from commercial banks and institutions. This frees up bank assetsthey now have more cash to loan. This
is a part of an expansionary or easing monetary policy which brings down the interest rate in the economy. The opposite is done in
case where money needs to taken out from the system. In the United States, the Federal Reserve uses open market operations to
reach a targeted federal funds rate. The federal funds rate is the interest rate at which banks and institutions lend money to each
other overnight. Each lending-borrowing pair negotiate their own rate and the average of these is the federal funds rate. The
federal funds rate, in turn, affects every other interest rate. Open market operations are a widely used instrument as they are
flexible, easy to use, and effective.

e. Introduce a Quantitative Easing Program

Unconventional monetary policy in which a central bank purchases government securities or other securities from the market in
order to lower interest rates and increase the money supply. Quantitative easing increases the money supply by flooding financial
institutions with capital in an effort to promote increased lending and liquidity. Quantitative easing is considered when short-term
interest rates are at or approaching zero, and does not involve the printing of new banknotes.

In quantitative easing, central banks target the supply of money by buying or selling government bonds. When the economy stalls
and the central bank wants to encourage economic growth, it buys government bonds. This lowers short-term interest rates and
increases the money supply. This strategy loses effectiveness when interest rates approach zero, at which point banks have to
implement other strategies to kick start the economy. Another strategy they can use is to target commercial bank and private
sector assets in an attempt to spur economic growth by encouraging banks to lend money. Note that quantitative easing is often
referred to as "QE."

Drawbacks : If central banks increase the money supply too quickly, it can cause inflation. This happens when there is increased
money but only a fixed amount of goods available for sale when the money supply increases. A central bank is an independent
organization responsible for monetary policy, and is considered independent from the government. This means that while a
central bank can give additional funds to banks, they can't force the banks to lend this money to individuals and businesses. If this
money does not end up in the hands of consumers, the lending to the banks will not impact the money supply, and therefore will
be ineffective at stimulating the economy. Another potentially negative consequence is that quantitative easing generally causes a
depreciation in the value of the home country's currency. Depending on the country, this can be a negative. It is good for a
country's exports, but bad for imports, and can result in the country's residents having to pay more money for imported goods.

In dire economic times, central banks can take open market operations a step further and institute a program of quantitative
easing. Under quantitative easing, central banks create money and use it to buy up assets and securities such as government
bonds. This money enters into the banking system as it is received as payment for the assets purchased by the central bank. The
bank reserves swell up by that amount, which encourages banks to give out more loans, it further helps to lower long-term
interest rates and encourage investment. After the financial crisis of 2007-2008, the Bank of England and the Federal Reserve
launched quantitative easing programs.