Question

What causes a shift in the demand and the supply of money?

Answer 1

“Demand” for money refers to the level of desire of holding cash by general population in an economy. This “Demand” is majorly impacted by two prime factors; (i) Level of nominal output in the economy (ii) Interest rates

Out of the mentioned two factors, interest rate is the main factor that has a direct implication on demand for money. Interest rate is the cost of money and hence, it determines demand levels for money in an economy. When interest rate rises in the economy, people tend to deposit their money to the banks and spend less to earn higher returns, which in turn results in declining demand for money. In the same way, when interest rate goes down, people prefer spending money rather than depositing it with banks as this becomes less attractive.

“Supply” for money refers to the money flowing into an economy. There are many reasons of shift in money supply, most of which are related to monetary policy. The major reason of shift in money supply is change in government borrowings.