Supply of money

Commerce study Manual STUDY MANUAL|PDF NOTES|SYLLABUS|REVISION

This refers to the stock of monetary items that are in circulation in an economy at a particular point in time.these items basically consists of;total currency ie notes and coins issued central bank and the total demand deposits.the following variables affects money supply;

  1. Policies of commercial banks-if more loans are offered to individuals and firms,money money is released in economy and the vice versa is true.
  2. Increase in national income-this increases economic activities resulting to money level in economy to increase and vice versa is true.
  3. Increase in foreign exchange-increased export earnings arising from increased export trade leads to an increase in money supply in an economy and the vice versa is true.
  4. Coins and notes offered commercial banks
  5. Central bank guidelines to commercial bank on cash reserve requirements.
  6. Government policies ie can be geared towards expenditure,borrowing which increases money supply,
  7. Open market operations activities.
  8. Interest rate policies
  9. Special deposits requirement CBK.
  10. A change in the public desired cash holdings.
  11. Balance of payment equilibrium or disequilibrium-disequilibrium translates to a net outflow of currency which leads to a reduced money supply.

Money supply is best understood through the concept of MONETARY POLICY.this can bedefined as a deliberate move government through the central bank to manipulate the supply ,availability and cost of money inorder to achieve the desired economic levels.The following are the various instruments /tools that commercial banks use in conjuction with the centaral bank to regulate the level of money supply/Methods of credit control.

  • The bank rate policy/bank intrest rates.
  • During inflation the Central Bank increases the commercial bank lending rates on loans making borrowing expensive ;translating to reduced money supply and during deflation the rates are lowered thus promoting borrowing.
  • Increased rates decrease the amount of currency in circulation while a decrease in rates increase the amount of money in circulation as in individuals are charged low interest rates
  • Open market operation:
  • This refers to sale and purchase of securities in the stock market. During inflation the central bank sells government securities (treasury bills and bonds)to withdraw an amount of money from the general public and during deflation it buys back the securities to increase currency in circulation.
  • Reserve requirements/cash/liquidiy ratio requirement.
  • Central bank requires commercial banks to hold a certain proportion of total deposits in cash form to meet the needs of those customers who may wish to withdraw cash.cash ratio=cash held/total deposit.if the central bank lowers this ratio then more money will be available for lending and the vice versa is true.This is meant to decrease or increase money in the commercial bank reserves.
  • Rationing of credit:
  • This is based on the size of loans a commercial bank is allowed the central bank.
  • Margin requirements:
  • The margin refers to the difference between a loan and a collateral security.
  • If the margin is big, loans will be expensive thus the public will shy away from borrowing loans thus money supply will reduce and if the margin is small the loans will be cheap thus many people will be more willing to borrow loans,increasing money supply in the economy.
  • Restricting terms of hire purchase agreement and credit sales
  • Here the Central bank may encourage or discourage the purchase of commodities on installments. To discourage it, the payment period is decreased and deposit fraction raised to discourage buyers from buying on credit thus releasing some lump some of money which they could be holding,and the vice versa is true.
  • Direct action, requests ,Moral persuasion and publicity:
  • CBK Directs the commercial banks to advance loans to a given amount. Directs the commercial banks to behave in a defined way ie expand or contract credit creation activities.  Reports on financial matters related to commercial banks encourage banks to change their policies.
  • Compulsory deposit requirements-CBK may require commercial banks to maintain certain amounts of deposits with it in special accounts whose money would stay frozen.this act has effect of reducing amount of money available to commercial banks for lending which implies a reduction in money supply.if the CBK wishes to increase supply of money,it may reduce/release the deposits to commercial banks.
  • Selective credit control-CBK may give special instructions to commercial banks and other money lending instructions as to the type of sectors to give credit to and ones which credit should be restricted to.
  • Loans to banks and discount window-this allows eligible institutions to borrow money money from central bank usually to meet short term liquidity needs.
  • Gentlemen agreements-these are voluntary agreements between central bank and banks aimed at improving monetary conditions in economy.in Tanzania,such agreements have been used between central bank and the largest commercial bank in an effort to lower spread on interest rates.



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