Money supply formula: How to calculate money supply?

Money supply formula: How to calculate money supply?

What is the money supply?

The total amount of money in existence at a given time is the money supply in an economy. Cash and its substitutes, such as coins, bills, and bank deposits, are examples of this. It is an important idea that has a big impact on a nation’s finances and economy. The money supply of a country is determined by the size of the money base and the money multiplier. Money supply formula can be derived by the money base multiplying from the money multiplier. So, MS (Money Supply) = MB (Money Base )x MM (Money Multiplier). The size of the money base is typically decided by the nation’s central bank. Keep in mind that the money base consists of both currency in circulation outside of banks and reserves in vaults.

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The money supply curve shows the relationship between the quantity of money supplied and market interest rate.  A county’s money supply curve is a vertical line. In other words, it is not an upward or downward curve. Because the money supply is not depend on the interest rate. So, the following graph shows the money supply of a country.

money supply curve

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Money Market Graph with Demand, Supply and Equilibrium

How to calculate the money supply?

The money supply of a country is determined by the size of the money base and the money multiplier.

Money supply of a country can be calculated using the money supply formula.

What is the money supply formula?

Money supply formula can be derived by money base multiplying from the money multiplier. Therefore,

Money Supply = Money Base x Money Multiplier

What is Money Base?

The size of the money base is typically decided by the nation’s central bank. Keep in mind that the money base consists of both currency in circulation outside of banks and reserves in vaults.

What is Money Multiplier?

The money multiplier or monetary multiplier is described as the highest level at which changes in the quantity of money deposited can affect the money supply. Since commercial banks accept deposits and hold the funds as reserves for a while before starting to distribute loans to the public in order to increase liquidity in the economy, this money multiplier effect is most often seen in commercial banks.

Calculate the money supply – example 1

Let’s apply the money supply formula to calculate the money supply.

If the money base of the US is $ 100 trillion and the money multiplier is 3, how much is the money supply?

Money Supply = Money Base x Money Multiplier

Money Supply = 300 x 3 = $ 900 trillion

What is the money multiplier formula

Money Multiplier = 1/ Reserve Requirement Ratio

The statutory required reserve (SRR) ratio in other words required reserve ratio is defined as the percentage of deposits that a commercial bank must hold in reserve. Commercial banks can’t lend or invest the amount of reserve requirement deposits.

In other words required reserve ratio/ SRR ratio means the proportion required to maintain as deposit liabilities by a commercial bank according to the instructions of the central bank. It helps to manage the liquidity level of a country. It is important to understand how the SRR ratio can be used to influence the money supply of an economy. Let’s assume that there is a deflationary situation in the nation. Then government wants to increase the output level by increasing the money supply of the nation. So central bank of the country reduces the SRR ratio. Then there is a lower requirement of deposit liabilities for the commercial banks. So, commercial banks can issue more loans. Finally, the money supply of the nation will be increased.

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Let’s use money supply formula and money multiplier formula to calculate the money supply

Calculate the money supply – example 2

Assume that the money base of Australia is $50 trillion. SRRR is o.2. So how much is the total money supply of the country?

Money Multiplier = 1/ Reserve Requirement Ratio

Money Multiplier = 1/ 0.2 = 5

Finally, we will calculate the money supply using the money supply formula

Money Supply = Money Base x Money Multiplier

So, Money Supply = 50 x 5 = $250 trillion

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