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Demand for money

What determines the demand for money:

  • Interest rates: Most critical.
  • Inflation: Increase the demand for nominal money.
  • Real GDP growth: Also increases the demand for money (nominal & real)

Money supply measures

  • M1 refers to all currency in the form of traveler's checking account deposits of individuals & firms and currency not held in banks.
  • M2 refers to M1 plus time deposits, savings deposits, & money-market mutual fund balances.

 Money Multiplier

The money multiplier for a change in the monetary base thus depends on both the required reserve ratio and the currency drain:

      Money multiplier = (1+ c) /(r + c)


Sample Question



What is the maximum increase in the money supply on Fed decision if (a) Fed buys $2billion in securities in the open market (b)required reserve ratio is 10% and (c)Currency drain is 2%?

A.  $20 bn
B.  $17 bn
C.  $16 bn


Change in quantity of money
= (1.02)/(.12) = 8.5; 2 X 8.5
= 17

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