Money supply explained

The term money supply is used by economists and finance experts to explain the total money in circulation in a country. Understanding it is important because it helps policy makers adjust money market indicators and thereby control inflation. In this article, we look at this in detail.

1. What's the money supply?

Money supply is the total money in circulation within an economy. It depends on the functional currency of that country. For example, the functional currency of Nigeria is the Naira. Therefore, the money supply is the total amount of Naira in circulation. This includes cash in the bank vault, those at the Central Bank of Nigeria, money that is easily convertible, as well as the cash in the wallet in your pocket. 

Normally, it is possible for the apex bank to know the amount of money in circulation. However, because of corruption, it will be difficult for them to do this. This is true, mostly in developing countries. However the war against corruption continues and probably things might get better someday. 

The MPC meeting is done after much consideration of the supply of money as well as other industrial and economic factors that are peculiar to Nigeria. As a result, the committee will only adjust the rate if the expected money in circulation is higher or lower than what they planned. 

2. The components of money supply

The supply of money is based on two components. In the first component, it is assumed that the supply of money includes money in the bank, cash, and fixed deposits. However, the second component included short term securities. 

M1: This is the money supply that includes cash in your pocket, cash at banks' vault, all finds in current and fixed deposit accounts. The M1 supply of money contains all physical or actual money you can think of.

M2: For M2, it includes M1 and all near money. That is, short term securities that are easily convertible to cash. You can think of all funds that are invested for less than a year as short term security such as treasury bills and commercial papers.