Factors That Affects The Determination Of Money Supply

Following are the major factors that affect the money supply in any economy:

1. Open Market Operations.
2. Reserve Requirements.
3. Public’s demand for cash balance.

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Describing the following factors at below

01. Open Market Operations

Open market operations are conducted by the Central bank as it carries out and implements monetary policy. The open market department of central bank buys and sells Treasury securities through a series of primary securities dealers.
Open Market Operations (OMO) activities are the primary tool that the Central bank uses in its implementation of monetary policy. Through the process of buying and selling Treasure securities through the open market operations, the Central bank either creates or destroys legal reserves in the banking system.

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02. Reserve Requirements

The central bank also has the power to set reserve requirements that apply to different types of deposits held in depository institutions. While changes in the reserve requirement does not affect the amount of legal reserve the banking system, a change in the reserve requirements will affect the money multiplier and the money expansion process.

If the reserve requirement is raised, the money multiplier will shrink and a monetary contraction process will take place, all other factors held constant. If the reserve requirement is lowered, the money multiplier and the monetary expansion process will take place, all other factors held constant.
While the Central bank has the power to increase and decrease reserve requirements on all types of deposits, they seldom choose this monetary policy tool as a means of affecting the money supply.

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03. Public’s Demand for Cash Balance

Another major factor that affects legal reserves in the banking system is the public’s desire to hold cash. There certain times of the year when the public, as a whole, prefers to hold higher cash balances. For example, during the months prior to Christmas many members of the general public increase their cash balances in order to do Christmas shopping. There is also often an increase in the public’s demand for cash during the summer months as many families travel on summer vacations.

Since legal reserves are defined as vault cash and deposits at the Central bank’s reserve, an increase in the public’s demand for cash balances lowers the amount of cash held in the vaults of depository institutions. This lowers legal reserves in the banking system and results in a contraction of the money supply, all other factors held constant.
As the public’s demand for cash declines, as is the case after the end of summer vacation or the end of the Christmas buying period, the cash is redeposit into bank. This increases in the amount of vault cash in the system, and results in the money expansion process taking place, if all of the factors are held constant.

Ashraful Haque Saimoom