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How Money Supply Influences Monetary Policy and Currencies

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What is the money supply?

The money supply is the handy indicator of a country’s economy. It is basically the complete availability of currency and also a group of safe assets that are primarily used to make payments or hold it as a form of short-term investment at a particular period. In other words, the money supply can be defined as the total volume of money that is in circulation in a specific period. It can incorporate valuables such as cash, coins, and currency balances.

The money supply balances are usually held in checking accounts and savings accounts. Economists find it to be a significant entity in studying long-term economic growth and short-term business cycles. Money supply also helps in the handling of the macroeconomic policy.

Economists analyze the money supply in the nation and establish policies related to it. The policies are brought up by varying the interest rates and by increasing or decreasing the amount of money flowing in the economy. Money supply affects quantities such as price levels, inflation, and the business cycle. Hence, it helps in the inspection of public and private sector performance.

Economic aspects:

As the money supply increases, there is a decline in the interest rates. This depreciation leads to an increase in the account size of the consumers and businesses. Therefore the demand for raw material also increases, and hence the production inflates as well.

Since a long time, it has been observed that the money supply, inflation & price levels are in a quite intense relationship. But, in recent times, there has been some instability in the relationship between these three and hence, the reliability of monetary policy from the money supply is less.

The next most crucial aspect of the money supply is its measurement. That includes monetary base (mb), M0, M1, and M2. Not all countries use the same standard. Each country uses a different measure.

The monetary base is the sum of circulated currency and reserve balances. Reserve balances are the assets held by banks and depository institutions in their accounts at the Federal Reserve.

M0 and M1 are those assets that can be effortlessly be converted into cash. M2 is the sum of M1, short-term time deposits, and money market funds. Similarly, M3 is the sum of M2 and long-term deposits.

What does money supply measure?

Money supply plays an essential role in the measurement of macroeconomic aspects and also guides in the formation of macroeconomic policy. It helps in guiding the monetary policy as well. Also, the increase or decrease in the inflation rate is determined by the money supply itself. Therefore, the money supply in the nation and the inflation rate are correlated with each other. If the money supply increases, the inflation rate automatically increases.

Reliable sources of information on money supply

The detailed information regarding the statistics of the money supply and the historical data related to money supply for the major countries is given in the links below. The web portal represents the money supply data in the form of a graph over a specified period. It also describes the statistics on interest rates, interbank rate, money supply M0, money supply M1, money supply M2, money supply M3, foreign exchange reserves, etc.

CHFhttps://tradingeconomics.com/switzerland/money-supply-m2

GBPhttps://tradingeconomics.com/united-kingdom/money-supply-m2

CADhttps://tradingeconomics.com/canada/money-supply-m2

USDhttps://tradingeconomics.com/united-states/money-supply-m2

EURhttps://tradingeconomics.com/euro-area/money-supply-m2

JPYhttps://tradingeconomics.com/japan/money-supply-m2

AUDhttps://tradingeconomics.com/australia/money-supply-m1

NZDhttps://tradingeconomics.com/new-zealand/money-supply-m1 

What do traders care about the money supply and what and its impact on the currency?

Traders and investors keenly look forward to the money supply changes in the economy. Traditionally, the money supply determines the demand and supply in the market. The money supply of the economy acts as a key indicator in determining the price fluctuations and liquidity of the securities, helping the investors make investment and financial decisions.

Moreover, the money supply has quite an impact on the currency as well. An increase in the country’s money supply causes the currency to decline. Contrarily, a decrease in the money supply causes the currency to appreciate.

For example, an increase in the Euro zone’s money supply results in the depreciation in the Euro. And, a decline in the Euro, appreciates the dollar rate. On the other hand, a decrease in the Euro zone’s money supply appreciates the Euro value and decreases the US dollar value. The reason for this to happen can be accounted for as, the change in the expected return on Euro deposits. Therefore, a reduction in the expected return on Euro deposits causes the currency to depreciate as well.

Frequency of release

The frequency of release of money supply M2 values for the major countries is typically fixed at 30 days, i.e., M2 values of GBP, USD, CAD, EUR, and JPY are released on a monthly basis. And the money supply M1 data of AUD and NZD are released monthly too where M2 is the sum of M1 and the short-term time deposits in banks.

Bottom line

The money supply of an economy guides for the establishment of macroeconomic policy and the monetary policy. The inflation rates are determined by the changes in the money supply. In the short-term scenario, an increase in the money supply lowers the domestic interest rates, decreases the rate of return on domestic deposits, and eventually depreciates the domestic currency.

Considering the long-term scenario, when the money supply changes permanently, the domestic currency depreciates very sharply, also causes the interest rates to return to its initial levels and leads to a long run declination in the exchange rate. The adjustment of prices happens only in the long run and results in overshooting of exchange rates, where overshooting explains about the volatility in the exchange rates.

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