Money supply

Question 1

Describe M0 and waht growth in M0 would inidcate

Answer 1

also known as ‘narrow money’ comprising notes and coins in circulation plus banks’ operational money held with the Bank of England. It is an indicator of consumer spending and retail sales.

Growth in M0 would suggest strong consumer spending while contraction in M0 suggests lack of confidence in consumers as they put all their money in the bank rather than spending it.

Question 2

Describe M4and what growth in M4 would indicate

Answer 2

Broad money – including all deposits created from the lending of banks and building societies and money held in
banks by savers in addition to notes and coins in circulation.

Growth in M4 would suggest that more lending is taking place while a contraction in M4 would suggest that lenders are reluctant to lend and therefore confidence may be
lower

Question 3

How can the money supply influence inflation?

Answer 3

Control of the money supply can be a key factor in controlling inflation. If people have more money in their pockets but supply of goods and services does not also rise, then people will compete for the fixed supply of goods, pushing up prices (once again our simple supply and demand diagram). By taking money out of the economy, what money people have is worth more to them and so they are less likely to spend it, reducing demand and controlling inflation.

Consider this with a simple example. If tomorrow the government printed so much money that each person could be given £1m, then suddenly no-one would think twice about spending £2,000 on a new TV.
Everyone would be fighting for the number of TVs on the shelves and prices would rise as retailers realised that they could sell their stock even at higher prices. Equally, if the supply of money were cut so that everyone felt the pinch, more people would think twice about spending money and the demand for those expensive TVs would fall as retailers have to offer discounts to shift stock.

Question 4

How is inflation measured?

Answer 4

Inflation is a measure of the increase in the cost of a “basket of goods and services” on a month to month basis and it can be measured in a number of ways (with different things included in the “basket”
depending on the measure).

Question 5

Describe disinflation

Answer 5

When inflation rises at a slower rate than they have been rising, this is known as DISINFLATION

Question 6

Describe deflation

Answer 6

Where prices actually start to fall, this is known as DEFLATION