Question

In: Economics

In the context of our reserve requirement economy, define ?1 M1 and the ???????? ???? Monetary...

In the context of our reserve requirement economy, define ?1 M1 and the ???????? ???? Monetary Base . Briefly explain how the two are related.

Solutions

Expert Solution

M1 is defined as a measure of money supply that includes physical currency and coin, demand deposits, traveler's checks, and other checkable deposits. It’s a narrow measure of money ,which is purported to reflect the medium of exchange attribute of money.

Its defined as—

M1= currency (with the public)+ demand deposits + other checkable deposits + travellers’ cheques.

The monetarey base , also referred to as high powered money or reserve money, is currency in the hands of the public (C) and commercial bank reserves (R) :

MB = C+ R

Besides the banks actual reserves, the currency held by the general public is also included in the reserve money because it could be readily transferred by them to the bank in exchange for bank deposits, in which case, the banks reserves would increase equivalently. The reserve money is also called the monetary base or the high-powered money, essentially because bank deposits (which are the major component of money stock)  are some multiple of the bank reserves through the family a process of multiple deposit creation. Accordingly, an increase in reserve money has potential, ceteris peribus, to bring about a multiple increase in bank deposits and hence in money stock.

The relation between M1 and monetary base is that both includes the component C, that’s currency in the hands of the public.


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