Impact of Macroeconomic Factors on Money Supply


Macroeconomic Inflation harms the real economy in two ways: it reduces economic efficiency along with the overall production. Firstly, the efficiency impacts: –

Inflation skews pricing and price signals, reducing economic efficiency. If the market price of an item rises, both buyers and sellers know that supply and demand circumstances for that good have changed, and they may respond accordingly. In contrast, excessive inflation makes it difficult to discern relative price changes and total price changes. Experts in Economics Assignment Help can help students with their economics assignments.

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Inflation also distorts money use. 

  • Currency has no nominal interest rate. 
  • If inflation grows from 0% to 10% yearly, the real interest rate on currency decreases from 0% to -10% annually. 
  • Individuals reduce their money holdings during inflationary periods because money has a negative real interest rate. 
  • Cash management is complicated in businesses. Instead of making productive investments, natural resources are spent to adjust to a shifting monetary yardstick. GDP and Money Supply

Money supply and GDP do not inherently impact one other, but monetary policy can affect both. Economic management monitors the money supply to allow transactions to occur. So, limiting the money supply will likely reduce the number of transactions, lowering the GDP. Insufficient money supply will cause transactions to halt. GDP is therefore inadequate as a measure of actual production since it is a statistic of the monetary worth of all trades. If money growth exceeds GDP, comparing the two numbers may help predict near-term inflation.

Money is raised NOT because of greater capacity to create but to allow higher ability potential to materialize. Money supply influences GDP by facilitating transactions. Everyone makes money. Therefore, you don’t need to find a trading partner. The more there is, the more significant the effect.

The banking system influences GDP, and banks boost the money supply when high growth. The Federal Reserve is involved, but the banking sector controls the dynamic features of the money supply.

Macroeconomic : Inflation and Monetary Transmission

Having reviewed the components of money, we now discuss how changes in the money supply affect production, employment, prices, and inflation. Concerned about inflation, the Reserve Bank has chosen to slow the economy. 

  • The Reserve Bank reduces bank reserves to begin the process. 
  • The Reserve Bank cuts bank reserves by publicly selling government securities. 
  • Each dollar decline in bank reserves causes a double contraction in checking deposits, lowering the money supply. 
  • The money supply is equal to currency plus checking deposits. Money supply contraction raises interest rates and tightens lending constraints. 
  • A diminished money supply will boost interest rates with no change in demand. Also, credit (loans and borrowing) will be less available. 
  • Mortgage rates will climb, as will company interest rates for new factories, equipment, and inventory. Higher interest rates tend to lower asset prices (stocks, bonds, residences) and lower people’s assets.
  • Interest-sensitive expenditure, especially investment, tends to decline as wealth declines. 
  • Lower wealth and increased interest rates diminish investment spending and consumption. 

Macroeconomic : Investment Plans

Businesses and governments will reduce investment plans. For example, increased loan rates may cause airlines to delay new aircraft acquisitions. Similarly, increased mortgage interest rates may cause people to downsize or modify their homes. Higher interest rates may reduce net exports in an economy more exposed to global commerce. Tight money raises interest rates and reduces expenditure on interest-sensitive aggregate demand components.

Finally, tight money reduces income, production, jobs, and inflation by lowering aggregate demand. Supply and demand analysis demonstrates how a decline in investment and other autonomous expenditures may significantly reduce production and employment. Also, when output and employment fall below normal levels, prices tend to climb slower or even decline, and inflationary forces wane.

The Central Bank’s decisions ultimately influence the money supply. The Central Bank decides the number of reserves, money supply, and short-term interest rates based on inflation and GDP numbers. Inflation and GDP data directly affect the money supply since they determine the amount of circulating money required by the Central Bank. In this process, banks and the public work together. Banks produce money by expanding reserves; depositors agree to store money.

Our regression study shows that both GDP and inflation rate substantially influence changes in money supply over a 15-year timeframe, and it explains the link between the dependent and independent variables.

Such macroeconomic variables like GDP and inflation rate significantly influence the money supply.

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