M1, M2 and the Importance of Banking Deposits in the Money Supply

Length: 2 Pages 604 Words

Introduction The aim of this paper is to describe different elements of the money supply, especially the M1 and M2 monetary items, as well as the importance of Banking Deposits for the Money Supply for a particular country. As it will be described below, the quantity of money present on the market is important for a country’s development and in most of the cases, it is a governmental control measure for keeping inflation and unemployment at low levels. A low level of money supply induced by the central authority with different measures, like the level of mandatory reserves, discount rate, has the purpose to slow down the national economy and reduce inflation. On the contrary, a high level of money supply present on the market will boom the national economy, creating new working places, therefore reducing unemployment and other negative social aspects. M1 stands for the section within Continue...

the money supply which is characterized by a high level of liquidity, including the cash under circulation (banknotes and coins) as well as easy convertible deposits. Individuals or corporation set up saving deposits for medium or long term periods, in which they put aside the excess of cash they possess. The need of liquid monetary instruments within an economy is vital for its future performance, as economic entities must meet the contractual obligations (for example, pay on time for the acquired merchandise). On the contrary, in case of low interest rates, individuals would tend to invest their funds in own projects, hoping to obtain a return rate higher than the one offered by the banks for their deposits. For example, a country with a high level of saving may offer extra opportunities for entrepreneurs in the form of bank credits, loans of other form of financing. Due to the above mentioned reason, the level of M2 within an economy is very useful to be monitored. Individuals decide to deposit their savings within banks or to invest them in personal or corporate projects. Importance of Banking Deposits in the Money Supply Money supply is a tool that dictates the performance of an economy. M2 is the part of the monetary supply, depicted by the term M1, plus saving deposits. Some of the consequences of this measure would be that companies would not be able to pay with cash their employees, the commercial relations within corporation would be based on barter or bank transfers, rather than cash transactions. In the absence of saving, entrepreneurs or other individuals with solid business ideas may not obtain financing for their projects, and their ideas could not be put into practice. This is the reason why the central bank has to adopt a monetary policy by which it could enable a stabilization of the money supply, within an equilibrium level in respect to the Money supply. A gloomy idea would be to decrease the liquidity level within an economy lower than the minimum level. As it was previously stated, the liquidity within an economy can be reduced by increasing the nominal interest rate, and so people would be encouraged to deposit their extra money in bank deposits.