Factors Affecting the Supply of and Demand for Money (Financial Economics)
- Levels: A Level
- Exam boards: AQA, Edexcel, OCR, IB, Eduqas, WJEC
The supply of money in a modern economy and financial system is determined by three key factors:
- “Open market operations” – this is effectively the same as Quantitative Easing. The Central Bank buys government bonds, effectively creating money
- The “reserve requirement” imposed on banks – this is the % of deposits made by customers at the bank that the bank must keep hold of rather than lending it out
- The policy interest rate set by the central bank – the rate of interest will influence how many households and businesses are willing and able to borrow. Most money in a modern economy is created by commercial bank lending so the rate of interest ultimately does have a bearing on the supply of money
Key factors affecting the demand for money
- The rate of interest on loans
- The number / value of monetary transactions that we expect to carry out
- The extent to which we also want to hold other financial assets, such as bonds, property, saving (this is also influenced by the rate of interest) – this is known as the speculative motive for holding money
- Changes in GDP
- The extent to which it is possible to use debit cards / credit cards i.e. the pace of financial innovation
- The extent to which we might have to pay out large unexpected payments, for example, for i.e. the precautionary motive
- The rate of anticipated inflation
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