SUPPLY OF MONEY

• The money supply is all the currency and other liquid instruments in a
country's economy on the date measured. The money supply roughly
includes both cash and deposits that can be used almost as easily as
cash.
• Governments issue paper currency and coin through some
combination of their central banks and treasuries. Bank regulators
influence money supply available to the public through the
requirements placed on banks to hold reserves, how to extend credit
and other regulation.
 Understanding Money Supply

• 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.
• 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. The money supply is
also known as the money stock.
 Effect of Money Supply on the
Economy
• An increase in the supply of money typically lowers interest rates,
which in turn, generates more investment and puts more money in
the hands of consumers, thereby stimulating spending.
• Businesses respond by ordering more raw materials and increasing
production. The increased business activity raises the demand for
labor.
• The opposite can occur if the money supply falls or when its growth
rate declines.
• Change in the money supply has long been considered to be a key
factor in driving macroeconomic performance and business cycles.
Money Supply Vs Interest rate
 The role of central bank in money
supply
• A central bank plays an important role in monetary and banking system
of a country.
• It is responsible for maintaining financial sovereignty and economic
stability of a country, especially in underdeveloped countries.
• The central bank has been described as the "lender of last resort," which
means it is responsible for providing its nation's economy with funds
when commercial banks cannot cover a supply shortage. In other words,
the central bank prevents the country's banking system from failing.
• However, the primary goal of central banks is to provide their countries'
currencies with price stability by controlling inflation. A central bank also
acts as the regulatory authority of a country's monetary policy and is the
sole provider and printer of notes and coins in circulation.
 The role of commercial banks
• The term commercial bank refers to a financial institution that accepts
deposits, offers checking account services, makes various loans, and
offers basic financial products like certificates of deposit (CDs) and
savings accounts to individuals and small businesses.
• Banks are fundamentally businesses organized to earn profits for their
owners. A commercial bank provides certain services for its customers
and in return receives payments from them.
• A commercial bank is where most people do their banking.
Commercial banks make money by providing and earning interest
from loans such as mortgages, auto loans, business loans, and
personal loans. Customer deposits provide banks with the capital to
make these loans.
 The stock market
• A stock market is a place where shares in publicly owned companies
—the titles to business firms—are bought and sold.
• In 2008, the value of corporate equities in the United States was
estimated at $21 trillion. The stock market is the hub of our corporate
economy.
• Every large financial center has a stock exchange. New York Stock
Exchange is America’s main stock market.
• Major ones are located in Tokyo, London, Frankfurt, Shanghai, and, of
course, New York.
 Risk and Return on Different Assets
• The rate of return is the total dollar gain from a security (measured as
a percent of the price at the beginning of the period).
• For savings accounts and short-term bonds, the return would simply
be the interest rate.
• For most other assets, the return combines an income item (such as
dividends) with a capital gain or loss, which represents the increase or
decrease in the value of the asset between two periods.
 Return
• The fact that some assets have predictable rates of return while others
are quite risky leads to the next important characteristic of investments.
Risk refers to the variability of the returns on an investment.
• If I buy a 1-year Treasury bond with a 6 percent return, the bond is a
riskless investment because I am sure to get my expected dollar return.
On the other hand, if I buy $10,000 worth of stocks, I am uncertain
about their year-end value.
• Individuals generally prefer higher return, but they also prefer lower risk
because they are risk-averse. This means that they must be rewarded by
higher returns to induce them to hold investments with higher risks.
• We would not be surprised, therefore, to learn that over the long run
safe investments like bonds have lower average returns than risky
investments like stocks.
• The formula for the total stock return is the appreciation in the price
plus any dividends paid, divided by the original price of the stock. The
income sources from a stock is dividends and its increase in value. The
first portion of the numerator of the total stock return formula looks
at how much the value has increased (P1 - P0). The denominator of
the formula to calculate a stock's total return is the original price of
the stock which is used due to being the original amount invested.
 Bubbles and Crashes
• Impatient souls might share the view of Keynes, who argued that
investors are more likely to worry about market psychology and to
speculate on the future value of assets rather than wait patiently for
stocks to prove their intrinsic value.
• When a psychological frenzy seizes the market, it can result in
speculative bubbles and crashes. A speculative bubble occurs when
prices rise because people think they are going to rise even further in
the future.
• A piece of land may be worth only $1000, but if you see a land-price
boom driving prices up 50 percent each year, you might buy it for
$2000 hoping you can sell it to someone else next year for $3000.
• History is marked by bubbles in which speculative prices were driven
up far beyond the intrinsic value of the asset.