Financial and Capital Markets Analysis: The Monetary System

You may come across much often to the headlines pointing out the current economic situation' as worst crisis since the Great depression. While the depression commonly attributed to October 1929's stock market crash, its primary cause as a matter-of-fact was ‘money’. The Great Depression had become more severe due to steady and dramatic decrease in the nation's money supply.

So, this must be a vital fact to remember that ‘the simple yet most important element in the study on financial system is ‘money’ and it is so basic element, people usually tend to overlook its utmost importance’.

Money Supply

The concept of money supply varies with the base instruments it includes, broadly money supply involves the sum of money representing amount of cash, electronic or bank deposits along with the paper currency as printed-paper notes and minted coins. More precisely Money supply includes ‘currency in circulation’ and demand deposits held at banks.

Central bank of particular nation controls money supply through various policy decisions. U.S. central bank’ The Federal Reserve controls the money supply through various policy instruments. The Federal Reserve publishes data on two money supply measures M1 and M2.

M1 as narrow term includes’ all currency (notes and coins) in circulation, all checkable deposits held at banks (bank money), and all traveler’s checks.

M2, somewhat broader measure of the supply of money, which includes all of M1 plus savings and time deposits held at banks.

An extensive measure of money supply data measure as M3 has cease to publish after Mar'06 on the Fed decision, as explained that M3 didn't convey more information about economic activity compared to M2, criticized widely by experts on the ground that M3 is the best description of how quickly the Fed is creating new money and credit.

Many economists believe that money supply plays a major role in the growth of the overall economy as it helps determining the level of interest rates, inflation and other economic growth triggers, and the Fed job is to control the monetary supply to help economy grows steadily without inflation.

Lastly, as mentioned above, you can briefly review the basic and initial concept for analyzing the present financial or monetary system, while taking account of its vital component as ‘money’. In the next article, we will review the role of U.S. Federal Reserve in the present financial system.

……To be continued.