The Traditional Models of Money Supply

The money supply is effectively determined as the total amount of money available in the economy at a given point in time. As such there are different scales or measures which determine the money supply in an economy. The most standard measures which determine the money supply in the economy are M1 and M2 which consists of different instruments that form the overall monetary base of any given economy. It is critical to note that the monetary base of an economy is determined both by the central bank as well as the commercial banks of the country and such the level of money supply change with the changes in the ability of commercial banks to create deposits.The traditional methods of determining the money supply have long been in demand and were wisely exercised by the central banks. However, the current credit crunch has resulted in the dynamic changes in the way monetary policy as a whole has been exercised. These changes include more aggressive cuts in the interest rates, use of the quantitative easing as well as innovation into the types of assets that are now accepted for repo transactions.The first part of this paper will discuss the traditional models of money supply whereas the second part of this paper will be discussing the practical application of these models and how things have changed especially after the current credit crunch.The monetary base of an economy comprises of M1 and M2 measures of the money supply. M1 comprises of currency in circulation, checkable deposits as well as travelers’’ cheques. M2 consist of M, saving, and time deposits as well as funds held by money market mutual funds. (Dornbusch, Fischer Startz.,2003)Central bank often requires the commercial banks to keep a certain portion of their deposits as reserves with the central bank. This is often done in order to control the money supply as by altering the reserve requirements, central banks basically aim to change the bank lending.