CHAPTER

MONEY SUPPLY
& MONEY DEMAND

Lecturer: Assoc. Prof., Ph.D. DANG VAN DAN

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 CONTENTS

1. MONEY DEMAND

2. MONEY SUPPLY

3. RELATIONSHIP BETWEEN MONEY DEMAND

AND MONEY SUPPLY

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1. MONEY DEMAND

1.1. DEFINITION
Money demand (MD) is the total amount of money needed

to circulate goods and services and store asset values in the

economy for a certain period of time.

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1. MONEY DEMAND
1.2. MONEY DEMAND THEORY
(1) Theory of Fisher

Money demand is a function of income,

interest rates do not affect the money
demand

P.Y
Md .V = P.Y → Md =
V
Irving Fisher
where:
(1867 – 1947)
Md: Money demand
P: Price
Y: Gross National Products
V: Velocity of money 4
1. MONEY DEMAND
1.2. MONEY DEMAND THEORY
(2) Theory of the Cambridge school

Money demand is a function of income

and interest rates. The speed of money
circulation is not constant.
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M d = k.P.Y , k =
V
where:
Alfred Marshall
(1842 – 1924)
Md: Money demand
The head of the P: Price
Cambridge school
Y: Gross national product
V: Velocity of money 5
1. MONEY DEMAND
1.2. MONEY DEMAND THEORY
(3) Theory of Keynes

Money demand is a function of income and

interest rates. Money velocity is not a constant
and is positively correlated with interest rates.

Md
P
( )
= f i, Y
− +

where:
Md/P: Money demand
John Maynard Keynes
(1883 – 1946)
P: Price
i: Interest rates
Y: Gross national product 6
1. MONEY DEMAND
1.2. MONEY DEMAND THEORY
(4) Theory of Friedman
Money demand is a function of income and expected
returns of other assets compared with the expected
returns of money.

Md  
= f  YP , rb − rm , re − rm , Π − rm 
e

P  + − − − 
Milton Friedman where:
(1912 – 2006) Md/P: Money demand
Yp: Income
rm: Expected return of money
rb: Expected return of bonds
re: Expected return of equity
e: Expected inflation rate 7
1. MONEY DEMAND

1.3. DETERMINANTS OF MONEY DEMAND

✓ Income
✓ Opportunity cost of money holdings
✓ Development of payment systems
✓ Public psychology and habits

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2. MONEY SUPLLY

2.1. DEFINITION

Money supply (MS) is a real amount of money in circulation

in a certain period of time.

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2. MONEY SUPLLY

2.2. MEASURES OF MONEY SUPPLY

✓ Narrow money measure: M1 = M0 + D
✓ Intermediate money measure: M2 = M0 + D + T
✓ Broad money measure: M3 = M0 + D + T + K
✓ Asset money measure: M4 = M0 + D + T + K + S

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2. MONEY SUPLLY

2.2. MEASURES OF MONEY SUPPLY

(1) Money supply M1

M1 = M0 + D

MS1 = M0 + D

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2. MONEY SUPLLY

2.2. MEASURES OF MONEY SUPPLY

(2) Money supply M2

M2 = M0 + D + T

MS 2 = M0 + D + T

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2. MONEY SUPLLY

2.2. MEASURES OF MONEY SUPPLY

(3) Money supply M3

M3 = M0 + D + T + K

MS3 = M0 + D + T + K

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2. MONEY SUPLLY

2.2. MEASURES OF MONEY SUPPLY

(4) Money supply M4

M4 = M0 + D + T + K + S

MS4 = M0 + D + T + K + S

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2. MONEY SUPLLY

2.3. PROCESS OF MONEY SUPPLY

MONEY SUPPLIERS

CENTRAL BANK

• Monetary Base (MB)

COMMERCIAL BANKS

• Creating bank-money (D)

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2. MONEY SUPLLY

2.3. PROCESS OF MONEY SUPPLY

(1) CENTRAL BANK (supplying MB)

▪ Title: Monetary Base

▪ Monetary base is the amount of cash that the central bank

issues in the economy

▪ Equation: MB = M0 + R = M0 + (RR + ER)

where:
M0: Total cash outside of the banking system
R: Reserves in the banking system
RR: Required reserves
ER: Excess reserves 16
2. MONEY SUPLLY

2.3. PROCESS OF MONEY SUPPLY

(2) COMMERCIAL BANKS (supplying D)

Maximum bank- Non-maximum bank-

money creation money creation

1 1
D = .M D= .M
r r+e+c
CONDITIONS CONDITIONS

1. 100% loans by bank transfer 1. Loans in both cash and bank

transfer
2. Without excess reserves
2. With excess reserve
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2. MONEY SUPLLY

2.3. PROCESS OF MONEY SUPPLY

* RELATION OF MB & D

1
D = MB.
r+e+c
Required reserve ratio

Excess reserve ratio

Ratio of cash use

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2. MONEY SUPLLY

2.3. PROCESS OF MONEY SUPPLY

* Determining money supply M1

MS = M 0 + D
 MS = c.D + D
 MS = D. ( c +1)
1+ c
MS1 = .MB = m1.MB
r+e+c

Money multiplier with money supply M1

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2. MONEY SUPLLY

2.3. PROCESS OF MONEY SUPPLY

* Determining money supply M2

MS = M 0 + D + T
M0 T
 MS = D. + D + D.
D D
 M0 T
 MS = D.  +1 + 
 D D 
 MS = D. ( c +1 + t )

1+ c + t
MS2 = .MB = m 2 .MB
r+e+c
Money multiplier with money supply M2 20
 2. MONEY SUPLLY

2.4. DETERMINANTS OF MONEY SUPPLY

1+ c
MS1 = .MB = m1.MB
r+e+c
Factors Relationship with MS Explanation

MB

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2. MONEY SUPLLY

2. 4. DETERMINANTS OF MONEY SUPPLY

✓ Monetary base
✓ Required reserve ratio
✓ Ratio of cash use
✓ Excess reserve ratio
✓ Time deposits ratio

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3. RELATIONSHIP BETWEEN MONEY DEMAND AND MONEY SUPPLY
(ECONOMIC CONTROL BY MONEY DEMAND AND SUPLLY)

Interest Interest
rate rate
i1 i1

i2 i2

MS1 MS2 Loanable I1 I2 Investment

fund
I1 I2 Investment

o1
o2

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