Question

1. what are the types of money supply?

2. what is the relationship between money supply and interest rate ?

Answer 1

1. Money supply refers to the currency or money in circulation in the Economy at any point of time.

• There are four main types of money supply with different from one another in terms of liquidity. They are : M0, M1, M2, M3
• M0 - This type of money includes deposits in reserve banks and currency in circulation.
• M1 - It includes coins and notes that can be easily converted into cash.
• M2 - it includes M1 + money market funds and demand deposits like the current account and savings accounts.
• M3 - it includes M2 + time deposits.

2. Money supply and interest rates are said to have negative relationship with each other.

When Fed Increases the money supply in the economy, the inflation rate rise and the money circulates at High speed in the economy. The banks have more reserves with which they can lend more to customers. This will eventually lead to a decline in the interest rates in the ecomomy.

Similarly, when Fed decreases the money supply in the Economy, the inflation rates fall too and the quantity of money circulating in the ecomomy declines, which eventually leads to a rise in the interest rates.