Demand and Supply of Money

Demand for Money

Demand for money refers to the tendency or desire by an individual or general public to hold onto money instead of spending it.it is also known as liquidity preference. Money can be hold by individuals in various forms and these include; currency notes and coins, securities e.g. treasury bills and bonds, demand deposits held in current accounts of banks, time deposits held in fixed deposit accounts. Demand for money (desire to keep money instead of assets) depends on three motives:

  • The transaction motive: here one holds money with a motive of meeting normal daily expenses e.g. buying food, entertainment, paying wages, postage, travelling, buying raw materials, etc.
  • The precautionary motive: this is where people tend to hold money to meet expenses that might occur unexpectedly or emergencies e.g. sickness, accident, or loss of property through theft.it is obvious that optimistic and risk takers will keep less money while pessimistic/risk averse will keep more money.
  • The speculative motive: Money may be held to be used in future especially when people anticipate that the prices of goods and services will be lower than they are presently and one plans to invest in opportunities that will bring more gains/returns. Such money is said to be held in a speculative motive. Money held for this purpose depends on levels of income and how optimistic/pessimistic people are about future happenings.

Supply of Money

The supply of money refers to the stock of monetary items that are in circulation in an economy at a particular point in time. These items basically consists of total currency, i.e. notes and coins issued by central bank and the total demand deposits. The following variables affects money supply:

  • Policies of commercial banks: if more loans are offered to individuals and firms, money is released in economy and the vice versa is true.
  • Increase in national income: this increases economic activities resulting to money level in economy to increase and vice versa is true.
  • Increase in foreign exchange: increased export earnings arising from increased export trade leads to an increase in money supply in an economy and the vice versa is true.
  • Coins and notes offered by commercial banks
  • Central bank guidelines to commercial bank on cash reserve requirements.
  • Government policies i.e. can be geared towards expenditure, borrowing which increases money supply,
  • Open market operations activities.
  • Interest rate policies
  • Special deposits requirement by CBK.
  • A change in the public desired cash holdings.
  • Balance of payment equilibrium or disequilibrium: disequilibrium translates to a net outflow of currency which leads to a reduced money supply.

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