A type of financial
asset that has long been believed to have special macro-economic significance
is money.
Money is the
economist’s term for assets that can be used in making payments such as cash
and cheque
accounts. One reason
that money is important is that most prices are expressed in units of money
used in the
three markets in our
model of the macro-economy. The three markets are the labor market, the goods
market and the asset
market. By asset market we mean the entire set of markets in which people buy
and sell
real and financial
assets, money just like every other commodity or financial asset has its own
demand and
supply. In this unit,
we shall consider the Supply of Money, in the asset market.
Supply of Money
The supply of money
in any economy at any particular period is the total sum of all money held by
all
members of the
society. Generally, money supply is taken as the total amount of money in
circulation at any
given time e.g. units
and coins and demand deposits in commercial banks.
Afolabi (1991)
explained “Supply of Money” as the amount of money which is available in an
economy in
sufficiently liquid
and spendable form. “What constitutes the components of this supply of money
depends on
what has been
officially accepted as the constitutes of Money Supply for that country”. Thus,
each country’s
money supply
definition may be unique.
Ajayi and Ojo (1981)
defined money supply in Nigeria as the total sum of currency outside the banks,
demand deposit at
Commercial Banks, domestic deposits with the Central Bank less Federal and
State
Government’s demand
deposits with the Central Banks. They proved that the preponderance of the
money
supply in Nigeria
consisted of currency outside banks and this probably still applies.
Bowden (1986:114) an
American author simply defined it as the actual number of “spendable dollars”
in
existence. At first
instance, his definition appears to refer only to the physical dollar in
circulation. But notice
that he put the
“spendable dollars” in quotes. He used this term to include money created by
the banking
system such as demand
deposits, which can be used to pay for debts by the issuance of cheques. Money
supply is, therefore,
the quantity of money available for spending at each point in time.
Determinants of Money Supply
It is normally
assumed that the nominal money supply is exogenously determined i.e. it is
supplied by the
monetary authority or
Central Bank. But the real money supply is endogenously determined since the
price
level variation
cannot be fixed.
Ajayi and Ojo (1981)
have also established that the following three economic factors determine the
supply
of money or the
quantity of money in the economy.
(a) The behaviour of
banks concerning the amount of reserves that they want to hold. This decision
on
reserves is a
function of the profit maximising behaviour of banks and the expectation of the
managers
with respect to
economic environment
(b) The behaviour of the non-bank public with
respect to the way they divide their wealth or money holdings
between cash and
demand deposits (i.e. the proportion of total wealth that people want to hold
in
cash).
(c) The behaviour of
the Monetary authorities with regards to the decisions about the size of the
monetary
base, Legal reserve
ratio, and the discount rate. (The monetary base is the currency in circulation
plus
all the assets that
banks are allowed to count while computing their legal reserve ratio).
In determining the
level of money through the exogenous factors, the government increases or
reduces the
supply in accordance
with the desired economic target they want to achieve.
Ojo, M. O. (1993)
puts it this way “a Monetary Control framework begins by establishing a link
between
the monetary control
instruments and the ultimate target for output, growth, inflation and the
balance of
payments”.
Money Stock Composition (Measuring Money)
Another important
disagreement among economist is what to include or exclude in measuring the
money
stock. This
disagreement, as Checkley P. (1980) explained arises because assets fulfill
some of the functions
of money but not all.
Focusing only on
those assets that serve directly as a medium of exchange and are generally
acceptable in
setting financial
obligations, we get the M definition of money stock. The M definition comprises
currency
in circulation and
demand deposits.
The monetarists led
by Professor Milton Friedman of University of Chicago argue that savings and
demand
deposits should be
included in money supply because they constitute “temporary abode of purchasing
power”. This
definition of money stock as M plus savings and Time deposits is called M .
This also agree
with Keynesian
interest sensitive demand for money.
These two definitions
M and M were the only ones existing until 1970s. With new developments in the
banking system, two
economists Gurley and Shaw quoted in Checkley (1980) argued that quasi-money
should be included
because they serve as good substitute for money. This led to M definition of
money stock
as M plus deposits
held in non-bank financial institutions. Money stock was later expanded to
include investments
in government
securities because they are easily cashable. This led to M definition of money
as M 4 3
plus investment in
government securities. In definition of money stock in Nigeria, the Central
Bank of Nigeria
focuses on M and M .
Factors that affect Money Supply
The general belief is
that the Central Bank of Nigeria issues units and coins on behalf of the
Federal
Government, it must
be the Central Bank that determines the stock of money supply, this may not be
entirely
true.
Afolabi (1991) has
given five factors that could affect money as follows:
(i)
Monetary base or High Powered Money: The money supply will
naturally increase if the Central
Bank expands the
monetary base. The monetary base or high powered money is the total of bank
reserves plus currency
in the hand of the public.
(ii)
Credit Creation: When banks create credit, the credit will in turn lead to demand
deposit and so on.
The extent to which
commercial banks are allowed to create credit will therefore affect the extent
of
money supply.
(iii)
Portfolio behavior of the Public: If most people keep their
money in the bank, the banking system
will have Liquid
reserves to lend out and create derivative deposit which is the deposit created
through
lending. If the
marginal propensity to hold currency increase, the Liquidity of commercial bank
will go
down and money supply
will similarly fall.
(iv)
Reaction policies of the Central Bank: Monetary policies of the CBN
applied in reaction to the
dictates of the
economy will have effects on money supply.
(v)
Foreign Exchange Transactions: Domestication of Foreign
Exchange will have the tendency to
increase domestic
money supply.
Specifically, money
supply is also influenced by the other following factors:
(a)
Total reserves supplied by the Central Bank: If the total reserves
supplied by the Central Bank is
high, money supply
will be high.
(b)
Reserve Requirements: If the reserve requirement – percentage
of commercial banks deposits
legally required to
be kept with the Central Bank is high money supply will be low.
(c) If
the non-bank public increases its demand for time deposits, money supply will
increase.
(d)
Demand for Currency: If the non-bank public increases its demand for currency, money
supply will
increase.
(e)
Demand for excused reserves: If commercial banks demand
for excess reserves increases, money
supply increases.
(f)
Interest Rates: There is a positive relationship between money and interest rate.
That is, the higher
the interest rate the
higher the money supply.
(g)
The Bank Rate: If the rate at which commercial banks borrow from the Central Bank
or discount bill
rises, money supply
falls.
Problems in Defining Money Supply
There were
difficulties with the monetarist thesis, neither of which was satisfactorily
resolved.
First, in an advanced
and more important an evolving-financial system, it was not possible to define
the
stock of Money in an
unambiguous way, or at least there were a number of different but equally valid
definitions of the
money supply and there was no strong reason for choosing one in preference to
any other.
As we have seen,
money can be defined either narrowly or broadly. However, there are or have
been within
the Nigerian
institutional context a number of different definitions of the money supply.
The definitions change
frequently as does
the popularity of one measure over another which partly illustrates the
difficulty in trying
to pin down the
concept.
Conclusion
Money supply
represents the total amount of money in the circulation of a given country. It
comprises all
those things which
possess the characteristics of money. In Nigeria, money supply are broadly
classified into
two: (i) Narrow Money
Supply (M1) and (ii) Broad Money supply (M2).
In Modern economics,
the money supply is determined by the Central Bank such as Bank of
England, CBN.
The terms ‘money
supply and ‘money stock’ are used inter-changeably. The problem of defining
money supply is still
associated with a considerable degree of controversy.
Summary
In this unit, we have
tried to examine fully, the concept of money supply. In concluding our
discussion
of money supply, let
us make few observations about the supply of money. First, is that, it affects
the price
level and hence other
economic variables. The next observation is that, it expands as economics
activities grow.
Furthermore, as money stock increases, total spending increases. The money
supply in an
economy is influenced
by internal and external factors.
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