What is Money Supply?
Money supply refers to the total amount of currency issued by a country's central bank, encompassing both circulating and non-circulating money:
- Circulating money: Actively participates in economic transactions, directly influencing price levels as the medium for goods/services exchange.
- Non-circulating money: Primarily functions within financial systems (e.g., bank reserves, institutional holdings), exhibiting limited interaction with real economic activities.
Calculating Money Supply
The standard formula measures net currency issuance over a period (typically annual):
Money Supply = Currency Issued - Currency WithdrawnTypes of Money Issuance
| Category | Description | Economic Impact |
|---|---|---|
| Economic Issuance | Aligns with GDP growth needs; supports healthy economic expansion | Positive; sustainable |
| Excessive Issuance | Exceeds economic requirements; often indicates systemic imbalances | Negative; inflationary risks |
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The Money Demand Equation & Equilibrium Verification
1. Fundamental Equation
The theoretical framework for balanced money supply follows:
M_d = (ฮG ร P)/VWhere:
- M_d = Money demand
- ฮG = Goods supply growth
- P = Price level
- V = Money velocity (equilibrium value)
2. Real-World Cases: Japan vs. China
Japan (1971-2010s):
- 1980s: Stable alignment between supply/demand
- Post-1990: Volatile deviations (e.g., 1999 oversupply)
China (Reform era onward):
- 1980s: Relative equilibrium
- 1990s-Present: Cyclical imbalances (oversupply โ undersupply โ oversupply)
Empirical Analysis: Money Supply's Relationship with CPI & GDP
GDP Correlation
- 1979-2005: China's money growth consistently outpaced GDP expansion (avg. 17.5% vs. ~10% GDP growth)
- Key Observation: Monetary stimulus โ proportional GDP response (e.g., 2004 tightening still yielded strong growth)
Inflation Dynamics
| Period | M2 Growth | CPI Peak | Trigger Factors |
|---|---|---|---|
| 1988 | 28.1% | 18.5% | Price liberalization reforms |
| 1993-1995 | >30% | 15-30% | Investment boom & currency oversupply |
| Post-2000 | ~17.5% | <3% | Globalized economy & productivity gains |
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FAQ Section
Q1: Why does excessive money supply cause inflation?
A: When currency growth outstrips goods production, more money chases the same goods, driving prices up (demand-pull inflation).
Q2: How do central banks determine 'healthy' money supply levels?
A: They analyze GDP growth targets, historical velocity trends, and inflation thresholds to model equilibrium needs.
Q3: Can technology disrupt traditional money supply models?
A: Yes. Digital payment efficiencies increase money velocity, requiring adjusted calculations of optimal supply.
Q4: What's the danger of prolonged low inflation despite high money growth?
A: This may signal economic stagnation, where new money fuels asset bubbles rather than productive activity.
Q5: How does China manage money supply differently than Western economies?
A: Greater state control over banking allows targeted credit allocation, but risks policy-driven misallocation.