LESSON 2

INTRODUCING MONEY AND INTEREST RATES

Finance and Financial Markets| 1st Semester

THE MONEY SUPPLY

THE SUPPLY AND DEMAND FOR
Refers to the quantity of money in
MONEY
circulation within an economy. It is
Supply and demand for money is a
typically measured using various
fundamental concept in
concepts of the money supply
macroeconomics that plays a crucial
role in shaping the overall health and
The Key Measures for the Money
stability of an economy. Money serves
Supply are:
as a
1. M0 (Narrow Money)
● Medium of exchange
- The most liquid form of
● A unit of account
money, including physical
● A store value
currency (coins and
● A standard of deferred payment
notes)

The interaction between the supply of

2. M1 (Broad Money)
money and the demand for money
- Includes M0 plus demand
helps determine key economic
deposits, which are easily
variables like interest rates, inflation,
accessible funds. It
and overall economic activity
reflects the money
available for day-to-day
Not enough money will slow down the
transactions
economy, and too much money can
cause inflation because of the higher
3. M2.
price level
- Encompasses M1 and
adds a time deposit
Just as the demand for money is the
savings account and
demand for money to hold, similarly,
other near-money assets.
the supply of money means the supply
It is a broader measure of
of money to hold. Money must always
the money supply and
be held by someone, otherwise it
includes less liquid forms
cannot exist. Hence, the supply of
of money.
money means the sum total of all the
4. M3.
forms of money which are held by a
community at any given moment
LESSON 2
INTRODUCING MONEY AND INTEREST RATES
Finance and Financial Markets| 1st Semester
- The broadest measure of - considered instant loans
money supply includes to consumers and
M2 along with large time therefore are not a net
deposits, institutional addition to the money
money market funds, and supply.
other larger liquid assets.
The Bangko Sentral ng Pilipinas (BSP) is
5. L. responsible for determining the supply
- In addition to M3, this of money. It uses daily open market
measure includes liquid operations to influence the creation of
and near-liquid assets money by banks and to guide the
(e.g., short-term Treasury availability of money in the economy.
notes, high-grade
commercial paper and BSP also has an impact on the creation
bank acceptance notes). of money by banks through reserve
requirements and the discount rate,
The deposits of the public at banks that is, the interest rate at which banks
and other depository institutions are can borrow from the BSP as a lender of
considered money and are therefore last resort.
included in the Ml money supply. If the
public withdraws money from bank Changes in the supply of money will
deposits to hold money as personal affect the. interest rate and therefore
currency ("under the mattress"), this the cost of borrowing money. This will
increase in inactive money will affect have an impact on consumption and
the banks' ability to extend loans and investment levels in the economy.
will influence the supply of money.

Some common forms of public

payment may not count as part of the
supply of money.
● Cheque payments from one
person to another

THE DEMAND FOR MONEY

● Consumer credit cards
LESSON 2
INTRODUCING MONEY AND INTEREST RATES
Finance and Financial Markets| 1st Semester
The demand for money refers to the interest rates to rise. This kind of
amount of wealth that individuals and demand has a negative relationship
businesses want to hold in the form of with the interest rate.
cash or money in bank accounts for
transactional purposes. The rate of interest is the price paid in
the money market for the use of
1. Transaction demand money (or loans). The rate is a
- Money demanded for percentage of the amount borrowed.
day-to-day payments
through balances held by The opportunity cost of holding money
households and firms goes up if the interest rate increases,
(instead of stocks, bonds which may lead to decreased
or other assets). This kind consumption and increased saving.
of demand varies with Conversely, if the interest rate is low, it
GDP; it does not depend is relatively cheap to borrow money
on the rate of interest. and the quantity of money demanded
goes up. Therefore, the demand for
2. Precautionary demand. currency has a negative relationship
- Money demanded as a with the interest rate.
result of unanticipated
payments. This kind of EQUILIBRIUM IN THE MONEY MARKET
demand varies with GDP: Equilibrium in the money market
occurs when the demand for money
3. Speculative demand. equals the supply of money. This
- Money demanded equilibrium interest rate is referred to
because of expectations as the “market interest rate”
about interest rates in the
future. This means that If the central bank increases the
people will decide to money supply, it can lead to lower
expand their money interest, which may stimulate
balances and hold off on economic activity. Conversely, a
bond purchases if they decrease in the money supply can
expect result in higher interest rates,
potentially reducing economic activity.