Concept of Money Supply: Narrow and Broad Money

Meaning of Money Supply

The total volume of money that is being circulated in an economy during a given period of time is called money supply. It is the total sum of currency that is held by the public and the demand deposits by the public in the banks. The money supply is both stock and flow variable. Money supply becomes a flow variable when it is viewed over a period of time. The flow concept of money supply refers to the product of the stock of money supply held by the public and the velocity of circulation of money during a certain period of time.

The velocity of money circulation is the number of times the money changes hands in a given period of time. Here, money represents the stock variable at a point of time.

The money supply is controlled by the central bank. This is done to ensure the flow of the required demand for money. There must be equilibrium between money supply and money demand. If there is an excess money supply than its demand, then it will lead to inflation in the economy. Similarly, when there is excess demand for money, it will obstruct economic transactions and economic development.

Types of money supply:

Basically, there are two types of the money supply. They are explained as follows:

1. Narrow money (M1)
Narrow money supply refers to the sum of currency held by the public and demand deposits held at commercial banks including other deposits held at the central bank.

Symbolically;

M1 = C + DD ..... (i)

where,
C = Currency held by the public
DD = Demand deposits held by the public at banks and other deposits of central bank
M1 = Narrow money

2. Broad money (M2)
The broad money supply refers to the sum of narrow money and time deposit. The time deposits consist of saving deposits, fixed deposits, call deposits, and margin deposits.

Symbolically;

M2 = M1 + TD ..... (ii)

where,
M1 = Narrow money
TD = Time Deposits
M2 = Broad money