Imagine you are studying a small island economy.
If you wanted to predict things like inflation or business lending, it would be very important to understand the money supply to see how it changes.
Money is a difficult concept to define. Anything that can be traded for goods or services could potentially be considered “money”, but some money is accepted by many more institutions and therefore deemed to be more “liquid”.
In our small island economy, one form of money could be coconuts. But coconuts are hard to transport for the amount of wealth they store; it is very likely that some people would prefer to hold their wealth in tobacco leaves, thus, another form of money arises. If more people held their wealth in tobacco leaves, that form of money is considered “more liquid” because you would have an easier time trading it with people for different goods and services.
We will take a look at other types of money soon (in our calculations of M1 and M2).
What is M0 Money Supply?
The first calculation we will look at is for our general money supply (M0)…
M0 = [(1+cr)/(rrr+err+cr)] x MB
cr = currency ratio of banks
rrr = required reserve ratio of banks
err = excess reserve ratio of banks
This can also be written as…