Money Supply, Markets, and Economic Theories of Inflation
Understanding Money Supply
Money Supply refers to the quantity of money available to economic agents in an economy. It is composed of legal tender (cash) and bank money, which consists of deposits existing in financial institutions.
Cash Reserve Ratio: Controlling Money Creation
The Cash Reserve Ratio (CRR) is a key tool for controlling money supply. Each country's monetary authorities set a limit on money creation, requiring banks to hold a certain percentage of their deposits as cash reserves.
The Money Market: Short-Term Liquidity
The Money Market is where highly liquid, low-risk financial products are traded. These instruments, such as treasury bills and corporate commercial paper, are characterized by the high liquidity and solvency of their issuers in the short term. Additionally, the money market includes the interbank market, where financial institutions negotiate bank deposits. This allows banks to place their excess funds or obtain the necessary liquidity to meet their reserve requirements.
Capital Markets: Long-Term Investments
Capital Markets, on the other hand, deal with financial assets with maturities over one year. There are specialized markets where these assets are traded. Operations in the capital market are differentiated by the time of transaction:
Primary Market
This is where a security is negotiated for the first time. Banks often play a substantial role in advising companies issuing securities and placing them among their own customers.
Secondary Market
This market deals with the sale of already issued securities. By providing transparent information on prices and values and simplifying trading transactions, the secondary market facilitates investment liquidity. The stock exchange is the secondary market par excellence.
Monetary Policy and Its Objectives
Monetary Policy is a set of actions undertaken by monetary authorities to monitor variations in the amount and type of money and interest rates. Its macroeconomic objectives are:
- GDP growth
- Increasing employment
- Price stability
- External sector balance
The money supply is directly generated by monetary authorities through issuing and putting currency into circulation and implementing concrete measures to control the banking system.
Classical School: Quantity Theory of Money
Economists of the Classical School, based on the quantitative theory of money, consider that the only cause of inflation is increasing the amount of money above the level of production.
Keynesian School: Aggregate Demand and Inflation
After the Great Depression of 1929, the classical explanation of inflation lost validity. Economist John Maynard Keynes would offer a new interpretation of this phenomenon, linking increased prices with increased aggregate demand only when there is full employment of resources in the economy.
Monetarism: Friedman's View on Inflation
Monetarism was founded by the American economist Milton Friedman. Similar to the Classical School, this updated version is based on the quantity theory of money and concludes that inflation is always a monetary phenomenon.