Understanding Money Supply, Central Banks, and Inflation
Money Supply
The money supply is the set of means of payment that circulate in the economy at a given moment.
- A) To increase the money supply, the Fed can:
- Mint and issue more bills
- Reduce the reserve ratios of banks
- Increase loans to banks
- Make purchases on the open market
- B) To reduce the amount of money, the Fed can:
- Withdraw notes and coins from circulation
- Reduce loans to banks
- Perform sales transactions in the open market
Monetary policy is the use of these instruments to increase or decrease the money supply.
Cash at Bank
Cash at bank is the result of loan operations performed by banks when they use a part of their findings, similar to how goldsmiths used deposited money. Banks only need to have enough reserves to cover withdrawals. They receive deposits and pay a certain amount for them. When they began to collect on these loans, the banking business started.
The Central Bank
The central bank is a bank like any other, but with the difference that it is an institution that corresponds to the function of controlling all the money in the economy. Its functions include:
- Establishing goals and instruments of monetary policy
- Controlling foreign economic operations
- Supervising the financial system to ensure proper operation
- Authorizing the issuance of coins and bills
- Acting as a bank of banks
Examples: Bank of Spain, European System of Central Banks, European Central Bank.
Money Demand
Agents can demand money for several reasons:
- Demand for transaction: Agents normally demand money to make required payments.
- Demand for precaution: Agents are uncertain about the credits and debits they will have in the future; the greater the doubt, the greater the demand for money.
- Demand for money as a store of value: Those with wealth can vary their assets to take fewer risks. Keeping wealth in money is safe but unprofitable.
Inflation
Inflation is the continued strong rise in prices over time in the market economy. Prices play an important role; if changes occur in market prices, the economy deteriorates.
- How does inflation affect the economy?
- Workers lose purchasing power, which is the ability to purchase with the income they receive.
- Inflation also very negatively affects savings because reserves will lose value due to the price increase, leading people to try to spend these resources as soon as possible.
- Causes of Inflation:
- Monetary Inflation: Liberal economists say that inflation is caused by an excessive amount of money.
- Cost Inflation: Other economists argue that inflation is caused by unduly increasing production costs.
- Demand Inflation: Keynesian economists say that inflation originates from excess demand.
- Structural Inflation: This theory suggests that a lack of competition, where firms with great power dominate the market, causes prices to rise and draw benefits.
- Anti-inflationary Policies:
- Supporters of the monetarist explanation suggest keeping the amount of money constant.
- Some argue that inflation is caused by earlier increases in costs.
- Keynesian economists believe inflation arises from excess demand.
- Others advocate for the idea of a structural origin of inflation.