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Money Supply

Monetary based model of money supply through the principle of money multiplier (m).

Money multiplier (m) is the ratio of the aggregate stock of money available in the economy (M) to the size of high powered money (H).
It shows that the aggregate stock of money supply available in the economy is the product of the value of money multiplier times the size of high powered money.
There are many money multiplier models developed by different economists at different time period like:
-          General model (IMF model)
-          Cagan model
-          Friedman model
-          Luckett model
-          Pesek and saving model
-          Jerry & Jordan model and so on…
Out of them Jerry & Jordan model is taken as the best model of money multiplier that has 7 equations in hand as given as:
M = C + DD + OD ---------------------- equation (1)
H = C + R + OD ------------------------- equation (2)
R = r + D --------------------------------- equation (3)
D = DD + TD ---------------------------- equation (4)
K = C/DD or C = K.DD ---------------- equation (5)
t = TD/DD or TD = t.DD ------------- equation (6)
d = OD/DD or OD = d.DD ----------- equation (7)
M = aggregate money supply in economy
C = currency held by people in their hands/pockets
DD = demand deposits of public with BFIs (Banking and Financial Institutions)
OD = other deposits of public with central bank (government, government enterprises, foreign offices)
H = high powered money
R = total cash reserves of BFIs
r = cash reserve ratio in weightage average
D = total deposits of public with BFIs
TD = time deposits of public with BFIs
K = currency ratio
t = time deposit ratio
d = other deposit ratio
Substituting the equation (6) into equation (4) we get,
D = DD + t.DD
Or, D = DD (1 + t) --------------------- equation (8)
Substituting the equation (8) into equation (9) we get,
R = r.DD (1 + t) ----------------------- equation (9)
Substituting the equation (5), (7) and (9) into equation (2) we get,
H = K.DD + r.DD (1 + t) + d.DD
Or, H = DD {K + r (1 + t) +d}
Therefore, DD = H/ {K + r (1 + t) +d} --------------------- equation (10)
Substituting the equation (5) and (7) into (1) we get,
M = K.DD + DD + d.DD
Or, M = DD {K + 1 + d} ----------------------- equation (11)
At last, substituting the equation (10) into equation (11) we get,

which is known as the money multiplier.

Further, it shows that M is the positive function of both the value of m and H. hence, as the value of m or H increases, the value of M also increases and vice versa. Therefore the seen or visible variables in money multiplier models like K, d, r, t and H are known as the proximate determinants of money supply.
Here, the value of m is negatively affected by the value of K, t, d and r. Besides, the value of H, r, K, t and d are affected by many unseen factors which are known as ultimate determinants of money supply like:
-          H is affected by
o   NFAR (Net foreign asset reserve of the central bank)
o   NCG
o   CGEs
o   BFIs
o   CPS especially the employees of central bank
o   NML (Non-monetary liability)
o   OPAs used by the central bank
-          r is affected by
o   Availability of liquidity in financial market
o   Condition of money and capital markets
o   Effectiveness of monetary policy
-          K, t and d are affected by
o   Level of income and frequency of income received by people
o   Consumption and saving behaviors of people
o   Banking behavior of people
o   Development of banking system and expansion of banks
o   Inflation rate
o   Interest rate on deposits at banks



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