Money supply with the public is influenced mainly by the central bank of country and its commercial banks. Through its fiscal policy, the government also fleets, some extent, the supply of money.
The Central Bank and Money Supply: The central bank of a country affects money supply both directly as well a s indirectly. It is directly responsible for the issue of currency notes and coins. On the other hand, it can indirectly influence the deposit component of the money supply. We know that a commercial bank can create deposits keeping in view its cash balances. If the central bank uses methods to reduce the supply of cash balances with the commercial banks, the latter will be able to give less loans and advances and create less deposits. The opposite will be the consequence if the central bank uses its power to increase the cash balances with commercial, banks. In order to achieve this, the central bank uses various control instruments, like changes in statutory reserve requirements of commercial banks, changes in interest-rate structure of banks, open-market operations, lending policy towards commercial banks, etc.
Commercial bank and money supply:Commercial banks can create demand deposits or bank money. These deposits are created in two ways:
1) When people deposit their cash with the banking system, they convert their 'cash in hand' into demand deposits. These deposits are known as primary deposits.
2) The cash brought into the banking system through these primary deposits is then either used to buy financial assets from the market (e.g. bills, bonds, etc.) or lent to industry and business. We know that when any bank lends to a customer, it does-not give cash to him ; instead the bank credits the loan amount to the customer’s account, thus creating demand deposits in his name. Since, these deposits have been created on the basis of primary deposits these are known as derivative deposits. If banks are able to grant more loans on a given amount of primary deposits, it would result in more bank money. It must be noted that time deposits do not become the basis of credit creation because time deposits are not used as a means of payments - these are only savings for the specified period The capacity of the banking system to create bank money depends upon the following factors :
i) Availability of cash with the banking system
ii) Willingness to borrow from the banking system
iii) Ratio of cash to bank deposits
iv) Credit control policy of the central bank of the country
Government. and money supply: The Government also affects the supply of money. Whomever the government imposes taxes or borrows from the public, it reduces the volume of available money with the public. On the other hand, when government finds that its income through taxation and public borrowings falls short of its expenditure, it borrows from the central bank (against its own securities) to pay off its creditors Consequently, the availability of cask with the public and the banking system will increase. As the availability of cash with the public and the banking system changes, so does the economy's capacity to expand or reduce credit.
It may, therefore, be concluded that the supply of money in an economy increases under the following situations:
1) when the public wants to hold less cash with themselves and is willing to borrow more from the banking system;
2) when commercial banks expand their credit operations;
3) when the Central bank issues more currency or follows a monetary policy that helps in expanding credit.
